Accrual vs cash accounting: Which is right for your Canadian SMB?

Could your small business's financial statements be lying to you? The answer is probably “yes” if you are still using the cash accounting method. For example, a financial statement illustrating how much money you have earned over a period of time (income statement) will look very different if all your accounting is based on when cash flow happens, sales and purchases installments are due or paid as opposed to the accrual accounting, which records transactions when they are earned or incurred, not when cash changes hands.  While passion for your craft or service is very much needed, importance must also be placed on learning to master your financials. This article is going to go over the pros and cons of accrual accounting for BC companies, explaining when this type of accounting makes the most sense.  

What is Accrual Accounting?

Accrual accounting is an accounting method that records revenue and expenses when they are earned or incurred, regardless of when cash is exchanged. This contrasts with cash accounting, which only records transactions when cash changes hands. Consider a small Surrey business owner who sells in December but doesn't get paid until January. By recording revenue in December, you can reflect the actual financial performance of your business that month using accrual accounting. While cash accounting is relatively simple, accrual accounting reveals a deeper and more accurate financial picture, especially for businesses that are becoming more complex. Though some very small or hobby businesses may do better with the cash method, accrual accounting lends itself well to many businesses that are looking to expand or deal with invoices and longer-term contracts.  

Benefits of Accrual Accounting for SMBs in British Columbia

1. A Clear Financial Picture

One of the biggest advantages of accrual accounting is that it provides a more accurate and complete financial picture. By matching revenues with related expenses within the same reporting period, business owners can see exactly how profitable their operations are. For example, if you own a service-based business in Langley that works on a six-month contract with a client, accrual accounting allows you to recognize that revenue as it’s earned each month rather than in one lump sum when the contract is paid in full. This gives you a better understanding of your actual profitability during that period.  

2. Improved Decision-Making and Strategic Planning

Accrual accounting offers SMBs more reliable data, which is crucial for long-term financial planning and making informed decisions. When you can see your true revenue and expenses, you’re better equipped to forecast your cash flow, plan budgets, and make investment decisions. Imagine you run a seasonal tourism business in New Westminster. Your company might have large upfront expenses, such as marketing material creation, campaign design, launch, etc before your busy season begins. Accrual accounting ensures these expenses are recorded when they are incurred, helping you better align them with the revenue generated during the season.  

3. Attracting Investors and Lenders

In British Columbia’s competitive business landscape, securing funding or investments is often a crucial step toward growth. Financial institutions and investors generally prefer accrual-based financial statements because they present a more accurate view of a business’s performance. Let’s say a growing startup in Surrey is seeking funding to expand operations. Accrual accounting allows to show the value of contracts and sales that have been earned but not yet paid. This paints a clearer picture of a business’s trajectory and may increase your chances of securing the funds needed.  

Challenges and Drawbacks of Accrual Accounting

1. Complexity and Time-Consuming

While accrual accounting offers more insights, it’s also more complex to manage, especially for small business owners without accounting expertise. Tracking transactions that haven’t yet been paid or received can become burdensome, requiring detailed records and often specialized accounting software. Hence working with an accounting firm in British Columbia is recommended.

2. Potential for Cash Flow Mismanagement

Accrual accounting, while accurate in terms of overall financial health, doesn’t track your actual cash on hand. This could lead to situations where your financial statements look healthy, but you’re short on cash for daily operations. For example, a company may record a large contract as revenue in June, but if the payment isn’t received until September, the business may struggle to cover its day-to-day expenses in the meantime. Without careful cash flow management, this disconnect can lead to operational challenges.  

3. Requires Expertise

Accrual accounting isn’t something that most small business owners can handle without professional help. It requires not only an understanding of accounting principles but also the time and resources to manage the system properly. For example, a restaurant might need to account for its inventory, wages, and incoming payments all at different times. This requires a strong understanding of accounting processes, and in most cases, a professional accountant is essential. If you need accounting services for pubs and restaurants in BC, you can contact us!  

Accrual vs. Cash Accounting: Which is Right for Your Canadian SMB?

Deciding between cash and accrual accounting depends on your business’s size, complexity, and growth aspirations.  

Cash Accounting Pros and Cons

The cash accounting system is simpler to handle and should be ideal for a solo proprietor or a very small enterprise as it records cash that truly arrived in your accounts at the moment. However, this type of information can be deceptive in terms of evaluating long-term financial health because it does not assume anything for the money you owe and any expenses. An SMB in Surrey, for instance, may find that cash accounting is easy to handle when it is just starting, but as it grows and begins dealing with larger suppliers and more customers the restrictions of cash accounting become evident. The income stream will be a roller-coaster and it is hard to make long-term planning.  

Accrual Accounting for Growth-Oriented SMBs

For the majority of SMBs in British Columbia who are looking to grow or expand an accrual accounting system is best, as it paints a clearer picture of your business's financial health. Accrual accounting is particularly useful for larger contracts, dealing with multiple income streams or seasonally fluctuating income. Canadian tax laws typically make accrual accounting mandatory for bigger businesses too, as well, which is why you should always consult with an accounting firm in British Columbia.  

Conclusion

SMBs in British Columbia that need to prepare for future growth and maintain healthy financials should choose accrual accounting. It does require a bit more expertise and effort to maintain as compared to cash accounting, but the advantages —better insight into your financials, better decision-making capability, and easier access to funding— make it worthwhile. If you are unsure if accrual accounting is suited for your business or need help with financial management, consulting a professional accountant is essential. CJCPA is a professional accounting firm in BC that can give you the assistance required to ensure your profitability.