Friday, July 17, 2009

Cash vs. Accrual

After posting about basic accounting terms and their meanings last week, I received an email from one of my readers recently asking me to help her understand the difference between cash basis and accrual basis accounting. We emailed each other back and forth for a bit but after while I was just confusing her. I took a step back because I wanted to answer her in a way that would really help her instead of throwing a lot of theory at her.

I decided that I would share the explanation here. I'm really trying to break the bookkeeping and accounting thing down to something tangible and useful. I believe every planner should understand the basic dynamics in order to make informed decisions about their business. Here goes...

I believe the more logical accounting method for a service business is accrual basis. Why? For two, there is normally no tangible product being sold hence no need to record any inventory. Unless you rent decor items or have other streams of revenue that come from a tangible product, your only sales or revenue source is your time and expertise Secondly, the accrual method gives a better picture of the financial position of your company. For example:

You book a wedding in January. It's a June wedding. Your fee is $12,000; you require a 50% deposit and the balance two weeks before the wedding.

Under the cash basis method, you would recognize $6,000 in sales for the month of January and $6,000 in sales for the month of June. Throughout the six months, you will probably incur a steady stream of expenses.

If you were to look at the financial position of your company for the three months ended March, you would show one month that had revenue and three months of expenses. Looks a bit lopsided and unstable, don't you think?

Under the accrual basis method, you would recognize the sales evenly over the six months because generally, you provide your services evenly over those six months. This method will make your company's financial position look more consistent and stable. More importantly it gives you a clearer picture of your financial position.

Which is the easier to of the two methods? Hands down, the cash basis method is much easier with regard to the bookkeeping tasks you'll have to perform. Its also less complicated and easy to implement. Buy or pay for something...record it...DONE.

With accrual basis, you need to develop a system to record the transactions of your business. This requires more time and expertise, but its not rocket science...really. You just need a chart of accounts, a few spreadsheets and a commitment to stay on top of your bookkeeping.

I can hear each of you saying, "Huh? What are chart of accounts?" Okay, our next post will cover the chart of accounts for every wedding planner. I'll also cover how to record common revenue and expense items for both methods.

Please let me know if this is helpful or if you have questions!

Until then...

Aspire to Plan!


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