Sam’s Sports Bar had its grand opening last week, but I wasn’t able to get there so last evening I stopped in for dinner. Sam is a client of mine so I figured I would see how business was going so far. Sam actually sat down and joined me for dinner and we got into an interesting conversation about cash basis versus accrual basis accounting. It all started with one simple question.
“How do I account for customers who run up a tab and pay for it the following month?” he asked.
I explained to Sam the difference between accrual and cash basis accounting. “If you were to use the accrual basis of accounting, you would record these transactions as income whenever your customer runs up the tab. If the customer runs up a $600 tab in June and doesn’t pay for it until July, you will be reporting the revenue and sales tax in June even though you didn’t receive the cash until July. If you were to use the cash basis of accounting you would not record the sales revenue until you receive the money in July. The same applies to paying your vendors. If you are using cash basis accounting you would record the expense when you pay the vendor. Using the accrual basis, you would record the expense when the goods are received. Does that make sense?”
“It does,” Sam replied. “Which way should I be keeping my books? Is there more of a benefit using one versus the other?”
“Well, cash basis accounting is a very simple way to keep track of revenues and expenses. It works well with small to medium sized businesses that are simple in nature. Your primary focus would be on the amount of cash in the bank and making sure bills are paid. The accrual basis of accounting is a more complex way to keep track of revenues and expenses, but is more accurate. Revenues and expenses are matched when they are earned, which gives you a more meaningful picture of how the business is performing. It would require a bit more work but if you’re up for it, I believe that is the way to go,” I answered.
After thinking about the options, Sam decided to use the accrual method. I came back a week later to assist him with setting up the system.
To be continued….
