Making the Right Choice for Your Business

Here at Roger Boghani Tax & Business Services, we work closely with businesses every day to understand their needs and provide expert advice to help them achieve an optimal financial position by making the right choice for their business. 

The question of cash vs accrual accounting is one of the most fundamental choices you’ll make for your business finances.

When deciding between cash and accrual accounting, your business type and size play a pivotal role. Cash accounting is simplified and ideal for sole traders or small service-based businesses wanting a clear picture of actual cash flow. However, accrual accounting provides a fuller financial view, making it better suited to growing businesses, those with inventory, and depending on your business’s annual and GST turnover, the ATO will determine which accounting method you need to use.

Many small business owners aren’t even sure which accounting method they’re currently using, which can lead to serious financial mismanagement. For example, a small café tracks daily cash sales whilst also invoicing corporate clients with 30-day payment terms, mixing cash (recording cash when received) and accrual (recognising revenue when an invoice is paid). If this café pays suppliers immediately but doesn’t account for pending bills, it distorts its profit outlook. The risk with mismatched accounting is unreliable financial reports and unwanted cash flow surprises.

Another example could be a medium-sized corporate cleaning company operating on a cash basis that has $120,000 in unpaid invoices and $58,000 in outstanding supplier bills, creating a misleading impression of its profitability. The risk here is a blind spot to their real obligations.

It’s worth noting that the ATO allows businesses with an annual turnover under $10 million to choose between these methods. Throughout this guide, we’ll explore both approaches (and even a third option) to help you make the right choice for your specific situation.

Understanding the Core Difference: Timing of Transactions

Going back to what we said initially, it’s all in the timing. The basic distinction between cash and accrual accounting relates to when you record transactions in your books. This timing difference affects everything from your daily bookkeeping to annual tax returns and financial reporting.

Income Recognition: When Paid vs When Earned

Cash accounting records revenue only when payment is received into your bank account. If you send an invoice on Tuesday but don’t get paid until Thursday, the income appears in your books under Thursday’s date.

Accrual accounting, by contrast, recognises revenue when it’s earned, typically when you deliver a product or complete a service, regardless of when the money arrives. In the above example, the revenue would be recorded when the invoice was sent, on Tuesday.

Another example, with differing tax implications, could be: A carpenter completes a contract worth $11,000.00 in May 2023 but receives payment in July 2023. Under cash accounting, this amount would be recorded as income in the 2023-24 financial year when the payment arrived. Under accrual accounting, it would be recorded in the 2022-23 financial year when the work was completed. And this is where choosing between cash vs accrual accounting can play a major role.

Expense Recognition: When Spent vs When Incurred

Similarly, cash accounting logs expenses only when you physically pay bills. Until payment occurs, these costs don’t appear in your financial records.

With accrual accounting, expenses are recorded when they’re incurred, even if you haven’t paid for them yet. This creates a more complete financial picture by tracking accounts payable alongside your bank balance.

For instance, a business paying $150.00 monthly for website hosting decides to pay 12 months upfront ($1,800.00) on December 1st. Under cash accounting, the entire amount would appear as an expense in December. Under accrual accounting, it would be recognised as only $150.00 for December, with the remainder recorded as a prepayment asset. Prepayment assets are another consideration and can be of benefit to your business if managed correctly.

Impact on Financial Statements and Tax

The choice between cash and accrual accounting significantly affects your financial statements and tax position:

Financial Visibility: Cash accounting provides a real-time view of available cash but can mask future obligations. Accrual accounting reveals your true financial position by showing money owed to you and money you owe others.

Tax Implications: Your accounting method determines when income becomes taxable. With cash accounting, income isn’t taxable until received, which can provide tax timing advantages. Accrual accounting might require paying tax on income before you’ve received payment.

Cash Accounting: Simplicity for Small Businesses

Small business accounting doesn’t need to be complex; this is precisely where cash accounting shines. Functioning like a basic chequebook, cash accounting provides straightforward record-keeping that many small business owners find intuitive, manageable and simple to self-manage.

Who Should Use It? Gig workers, Freelancers, Sole Traders, and Service Providers.

Cash accounting works best for businesses with simple transaction patterns and minimal lag between delivering services and receiving payment. Ultimately, it suits:

• Sole traders and freelancers with straightforward finances
• Service-based businesses that receive immediate payment
• Retail shops and small service providers
• Startups and businesses just beginning operations
• Businesses without complex inventory management

According to the ATO, any business with an aggregated turnover below $10 million can choose the cash accounting method. For many small businesses, this approach aligns perfectly with their operational reality.

GST and Tax Planning Benefits

Besides simplicity, cash accounting offers notable tax advantages. When using this method for GST reporting, you only account for GST in the period when you receive payment from customers or pay suppliers. Consequently, this creates better alignment between your bank balance and tax obligations.

This timing advantage means you don’t pay GST on invoices your customers haven’t paid yet. Furthermore, businesses can time transactions strategically, perhaps delaying sending invoices at year-end to shift income into the next tax period, therefore reducing their taxable income for the current financial year.

Real-World Example: Party Planner or Plumber

Breaking this down even further, let’s compare two very different businesses: a Party Planner vs a Tradie. For party planners, cash accounting makes perfect sense. When booking a venue for an event in March but paying in April, you’d record the expense in April when the money leaves your account. This approach makes reconciling your books with bank statements straightforward, as transactions match when money enters or exits your account.

Likewise, a plumber would benefit from cash accounting’s simplicity. With materials being purchased in July and then invoiced when the job is completed in August.

In the case of either cash or accrual accounting, cash flow management becomes essential when credit terms are involved. If you complete jobs but allow customers to pay invoices anywhere from 14-45 days after completion, you’ll need cash reserves to cover interim expenses like weekly wages. With either method, you need to be aware of the funds available to ensure your obligations can be met.

Limitations: No Accounts Receivable or Payable Tracking

Even with the advantages of simplicity, cash accounting has its limitations. With little to no visibility into future financial obligations or expected income, cash accounting doesn’t track accounts receivable (money owed to you) or accounts payable (money you owe others).

This missing financial information can distort your business’s true position. A business may appear financially healthy based on its current bank balance, yet still have significant unpaid supplier bills. Alternatively, a business that has completed substantial work but hasn’t yet been paid might appear less successful than it truly is.

Accrual Accounting: A Deeper Financial Picture

Unlike the simplicity of cash-based methods, accrual accounting offers a more sophisticated approach to financial management that provides deeper insights into your business’s financial position. This method records transactions when they occur rather than when money changes hands, painting a more comprehensive financial picture.

When is Accrual Accounting Ideal?

Accrual accounting shines for businesses with complex financial structures or those intending to grow, that are inventory or project-based. Particularly, it suits businesses that:

• Maintain physical inventory, as it allows proper matching of inventory costs with sales revenue
• Engage in long-term projects spanning multiple accounting periods
• Operate across multiple locations or handle large transaction volumes
• Sell products or services on credit terms

Any business with a turnover exceeding $10 million must use accrual accounting, along with publicly listed companies and some businesses and industries, as mandated by the ATO. If you’re unsure whether this will impact you and your business, reach out to us today to make an appointment and together we will ensure you meet your ATO obligations.

The Matching Principle Explained

At the heart of accrual accounting lies the matching principle: a fundamental concept requiring expenses to be recorded in the same period as the revenue they help generate. To give a clear example of this:

A Melbourne startup closed $2 million in annual subscriptions in December 2023. Their sales team earns 5% commission ($100,000), but payroll doesn’t process the payments until February 2024. Under accrual accounting, the company records the $100K expense in December 2023 financials, when the sales team earned the commissions, not when the cash left the account in 2024. This matches the expense to the revenue it helped generate, giving a true picture of the year’s profitability.

This method creates a more accurate representation of profitability by ensuring all costs associated with generating revenue appear in the same timeframe.

Accounts Receivable and Payable Visibility

This is where Accrual accounting comes into its own. By providing important visibility into future obligations and expected income through accounts receivable and payable tracking.

These accounts offer insights into:

• Money owed by customers (accounts receivable)
• Money owed to suppliers (accounts payable)
• Expected cash inflows and outflows

This visibility helps you manage your business cash flow forecasts and assess liquidity needs.

Real-World Example: Marketing or Building Company

Consider a marketing agency completing a campaign for a client in December but not receiving payment until January. Under accrual accounting, the agency records revenue in December when the service was delivered, reflecting actual performance.

Similarly, building companies benefit from accrual accounting’s ability to align expenses with revenue across long project timelines. A building company sending a bill for completed work records it as revenue immediately, although payment may come later. This approach offers businesses better insights into project profitability and overall business financial health. Accrual accounting is a way of playing the long game with a better view of overall financial health.

Ultimately, although accrual accounting requires more effort to maintain, it provides the most accurate view of your business’s financial position and performance. At Roger Boghani, we know each business’s needs are as individual as people, so to ensure the best advice for your business, please reach out to us to make an appointment.

Cash vs Accrual: Side-by-Side Comparison

Now that we’ve broken down the fundamental differences, let’s do a comparison. When examining cash and accrual accounting side-by-side, the differences become immediately apparent in how they impact your business’s financial reporting, operational decisions, and compliance requirements.

Income and Expense Timing Differences

Consider this practical example: A carpenter completes work worth $11,000.00 in May 2023 but receives payment in July 2023. Under cash accounting, this income appears in the 2023-24 financial year, whereas accrual accounting records it in 2022-23 when the work was completed.

It is worth seeking qualified advice regarding the best option for your business to ensure you manage the tax implications that each method brings.

Cash Flow Visibility vs Profitability Insight

Each method provides a different financial lens. Cash accounting delivers an immediate snapshot of available funds in your bank accounts. On the flip side, accrual accounting reveals your true financial position by showing both what people owe you and what you owe others.

When does this become important? This distinction becomes crucial during growth phases. As one accountant explains, “Profit and cash flow are two entirely different concepts. The concept of profit is somewhat narrow and only looks at income and expenses at a certain point in time. Cash flow is more dynamic and concerned with the movement of money in and out of a business”.

Software and Bookkeeping Requirements

Cash accounting typically requires less complex bookkeeping systems, making it suitable for smaller operations with straightforward transactions, such as small businesses, sole traders and freelance. However, accrual accounting demands more sophisticated systems to track accounts receivable, accounts payable, and adjusting entries. Accrual accounting requires a level of expertise not every business has on staff.

ATO Thresholds and GST Reporting Rules

The Australian Taxation Office has clear, established thresholds for accounting methods:

• Businesses with aggregated turnover under $10 million can choose either method
• Entities not carrying on business must have a GST turnover of $3 million or less to use cash accounting
• Businesses accounting for income tax on a cash basis can use cash accounting for GST

For GST reporting specifically, cash accounting means you account for GST in the period you receive or make a payment, aligning money flow with GST obligations. This provides better cash flow management, especially for smaller businesses.

When and How to Choose the Right Method

Selecting the right accounting method involves understanding the requirements of your business and any obligations and requirements of the ATO.

Below, we explore how to make this critical decision and what happens if you need to change methods, knowing you can shift from cash to accrual when the time is right, in line with ATO requirements.

ATO Eligibility and Turnover Thresholds

The Australian Taxation Office sets specific thresholds that determine your eligibility for different accounting methods. Initially, any business with an aggregated turnover below $10 million can choose either cash or accrual accounting for GST purposes. This threshold gives many small businesses flexibility in their accounting approach.

Checklist: Is Cash or Accrual Right for You?

When deciding between methods, consider:

• Business size and complexity: Straightforward operations typically suit cash accounting
• Industry type: Service-based businesses often benefit from cash methods, whereas manufacturing or inventory-heavy businesses usually need accrual
• Future growth plans: Growing businesses may need to switch to accrual eventually
• Software capabilities: Will your current systems support your chosen method?
• Resource availability: Do you have staff who understand accrual accounting?

Whenever you’re uncertain about which method suits your situation, I’d recommend speaking with us for personalised advice that considers your specific business circumstances.

Consideration must also be given to the time and expertise required to maintain accrual accounting. It may tick all the boxes (without being an ATO requirement), but it is not set and forget. It takes diligence and management to accurately maintain accrual accounting finances.

Switching Methods: What to Know

If the above has given you food for thought about your current accounting methods, it is good to know that switching is possible.

But changing from cash to accrual can only take effect on the first day of a tax period. Subsequently, in your first period using accrual, you’ll need to report GST on any sales invoiced before the change date but not yet paid, and claim previously unclaimed GST credits. It sounds complicated, but it can be achieved with the right planning and qualified support.

Hybrid Accounting: When It Works and When It Doesn’t

Having just stepped through cash vs. accrual, it’s hard to consider a third option. But there is one. Hybrid accounting. This combines elements of both methods, giving businesses flexibility to apply cash accounting to some transactions and accrual accounting to others.

A really clear example of this would be: A function’s venue in Sydney operates both a high-end restaurant and a busy events space, and it combines hybrid accounting to manage its finances. For the restaurant side, it records daily cash takings and food costs on a cash basis, reconciling sales when they close each night and supplier payments when they’re made. For functions, it switches to accrual accounting: recording revenue when contracts are signed (even if deposits arrive later) and recognising expenses like staff wages and equipment hire as they’re incurred, not when invoices are paid. This way, the restaurant’s day-to-day cash flow stays simple, while the events business gets an accurate picture of profitability per booking, crucial for seasonal peaks like wedding season and end-of-year parties.

This approach works well for businesses handling both routine expenses and complex projects with delayed payments. Given that hybrid methods introduce additional complexity, they’re best suited for businesses with distinct transaction types that benefit from different accounting methods. Reach out to us for further information and to determine if hybrid accounting might be right for you.

Aspect	Cash Accounting	Accrual Accounting
Transaction Timing	Record income/expenses when money changes hands	Record income/expenses when earned/incurred
Suitable For	– Sole traders/freelancers – Small service businesses – Retail shops – Startups – Businesses with immediate payments	– Growing businesses – Inventory-based companies – Project-based businesses – Multi-location operations – Businesses with credit terms
Financial Visibility	Shows real-time cash position only	Provides a complete financial picture, including future obligations and receivables
ATO Turnover Threshold	Allowed for businesses under <$10 million	Required for businesses over >$10 million
GST Reporting	GST is recorded only when a payment is received/made	GST is recorded when the transaction occurs
Bookkeeping Complexity	Simple for sole traders & freelancers, aligns with bank transactions	More complex, requiring sophisticated systems
Financial Tracking	No tracking of accounts receivable/payable	Tracks all accounts receivable and payable
Best For Cash Flow Management	Provides a clear view of available cash	Shows true financial position, including future obligations
Tax Timing Advantage	Income is taxed only when received	Income is taxed when earned, regardless of payment

The Right Accounting Method for Your Business

Having explored the nuances of cash and accrual accounting methods, we can see how each approach impacts day-to-day operations, financial reporting, tax obligations, and business operations.

Without a doubt, your choice between these methods will significantly influence your financial management strategy.

Cash accounting offers simplicity and immediate visibility of available funds, making it ideal for sole traders, service-based businesses, and smaller operations with straightforward transactions. This method aligns perfectly with businesses prioritising uncomplicated bookkeeping and clear cash flow tracking. Additionally, cash accounting provides tax timing advantages since income becomes taxable only when payment arrives in your account.

Alternatively, accrual accounting delivers a comprehensive financial picture by recording transactions when they occur rather than when money changes hands. This approach, although more complex, reveals your true financial position by tracking both accounts receivable and payable. Businesses with inventory, complex operations, or growth ambitions generally benefit from this method’s ability to match expenses with the revenues they generate.

As mentioned previously, the ATO provides flexibility for businesses under specific turnover thresholds, allowing many small enterprises to select their preferred method. However, as your business grows, you might need to transition from cash to accrual accounting to meet compliance requirements and gain deeper financial insights.

Ultimately, the right accounting method depends on your specific business circumstances, industry requirements, goals and plans. While this guide provides foundational knowledge, your unique situation might benefit from personalised advice. We recommend contacting us for tailored guidance and to schedule an appointment that addresses your specific accounting needs.

Whether you choose cash or accrual accounting, or the hybrid method, the most important factor is consistency and ensuring your chosen method accurately represents your business’s financial reality. Effective financial management forms the backbone of sustainable business success, regardless of which accounting approach you implement.

Final Thoughts

Deciding to run with cash or accrual accounting, or even the decision to switch, can change how you see your business finances. It’s about finding what helps you make better choices, for now and into the future. At Roger Boghani, our Business Services are here to make it simple: whether you prefer cash accounting for a quick overview or accrual accounting to track growth and projects more, the goal is to suit your specific needs.

We skip the jargon and keep things clear, offering advice that matches how your business runs. Want to figure out what works best? Let’s talk, because smart accounting starts with choosing the right path.