Two types of accounting methods are used in business: cash and accrual. Each method has advantages and disadvantages, which are mostly based on the type of financial transaction incurred through business operations.
Cash accounting is an advantage for companies because it is a simple system for recording financial transactions. Under the cash method, transactions are recorded when cash is received or spent in the business.
The biggest disadvantage with cash accounting is that Generally Accepted Accounting Principles (GAAP) does not recognise this method. Adjusting journal entries must be posted to so financial information is reported under the accrual accounting method.
Accrual accounting allows financial information to be recorded as transactions occur, regardless of when cash changes hands. This allows an even flow of financial information to be reviewed, helping managers understand how well their business is operating.
Accrual accounting is a detailed process that requires several closing entries to be posted at the end of each accounting period. Most businesses use an outside accountant for consulting purposes when using the accrual accounting method, which increases business expenses.
Cash accounting is a good accounting method when planning for taxes since companies can adjust their tax liability according to their business operations.
Accrual accounting helps create financial statement that accurately reflects business operations, allowing companies to apply for loans and seek outside investors.