When it comes to controlling your business finances, the correct accounting method can make all of the difference. You have most likely heard about cash basis and accrual basis accounting, but there is another choice which few people consider: Modified cash basis accounting. This hybrid technique blends elements of cash and accrual accounting, and it might just be right for your business. So, should your business use modified cash basis accounting? Let's see what it is, how it works and if it is right for you. We’ll also see how outsourcing accounting services in the USA can help your business.
What Is Modified Cash Basis Accounting?
Modified cash basis accounting combines cash basis and accrual basis accounting. It combines the simplicity of cash basis accounting (you record income and expense when money changes hands) with some accrual components.
With a modified cash basis, you'll still record most of your everyday transactions with a cash method. But for bigger, more permanent items like inventory, or loans, fixed assets, you will use accrual adjustments. This means that although your everyday expenses and income are monitored as cash moves, some items like depreciation on equipment or inventory levels are treated more like they would in accrual accounting.
Cash Based vs Accrual Based: What is the Difference?
Before you know how modified cash basis could possibly work for you, you should know the big difference between cash basis and accrual basis accounting.
Cash basis accounting
You record income whenever you get cash and expenses when you pay them. For instance, in case you operate a little shop and sell a product now and get paid out till next week, you will not record that sale till the cash is in your account. Similarly, you record expenses only when the cash leaves your hands.
Accrual basis accounting
You record revenue when it's gained and expenses when they are accrued, even if the cash changes hands. Using the shop example once again, in case you complete a sale today, you record the revenue even if the customer hasn't paid yet. This particular method reveals your financial health in one glance but is more complicated and time-consuming to handle.
Modified cash basis pulls from either method. It is essentially a cash basis with the option for accrual adjustments where appropriate.
Why Make Use of Modified Cash Basis Accounting?
You may ask "Why use modified cash basis when cash basis appears easy enough?" Cash basis accounting is easy for many but it does not always provide you with a full picture of your business's financial condition - particularly in case you have long-term assets like inventory or equipment.
Modified cash basis tracks long-term assets and liabilities without the full accrual accounting complexity. For these reasons you may want to consider this hybrid approach:
- Better Financial Insight: In case you make use of cash basis accounting only, you might not know precisely what your business owns and owes. As an example, in case you purchase equipment or purchase inventory, you will not know how those affect your finances till the cash leaves your account. Modified cash basis records these items on an accrual basis so you understand your true financial position.
- Simpler Than Full Accrual: Accrual accounting is a lot of work for small companies. It requires you to track every sale even in case the payment has not yet arrived and every expense even when you still haven't paid it yet. This is exactly where a modified cash basis works. It keeps you on a cash basis for daily transactions but gives you accrual for things like loans or depreciation.
- Cost-Effective: Many small businesses can not afford to work with a full time accountant or bookkeeper to manage accrual accounting. Modified cash basis offers you more versatility and understanding of your business with no full-time cost of accrual accounting.
Who Should Use Modified Cash Basis Accounting?
Modified cash basis accounting is not for everybody but can work for many small businesses. How to tell whether it is right for you:
- Privately Held Businesses: In case your business is privately owned and you do not require audited financial statements, then modified cash basis could be for you. Public companies and those needing their books audited must use full accrual accounting, though private businesses are often more adaptable.
- Businesses with Inventory or Large Assets: If your business handles inventory or has costly equipment, modified cash basis may provide the additional detail you need. For instance, in case you operate an e-commerce company and have to track inventory without changing to complete accrual, modified cash basis enables you to do so by making little changes without totally switching your accounting technique.
- Easy Day-to-Day Transactions: If your daily transactions are relatively simple (like an independent service or a tiny retail shop) but you require more detail on long-range items then a modified cash basis gives you that balance. You can use a cash basis for most things and adjust for larger things that will affect your business over time.
- Businesses That Do Not Need Full Accrual: In case your business needs more detail than accrual accounting provides but cash basis simply feels way too easy, modified cash basis can be the middle ground.
How Does This Look In Your Financial Statements?
With a modified cash basis, your financial statements will include some cash and accrual transactions. As an example, your income statement might still show a cash basis: income received and expenses paid. However with your balance sheet you may make accrual adjustments for long-term assets like inventory or equipment depreciation.
This hybrid approach provides you with a wider picture of your business finances but keeps things fairly simple.
Conclusion: Is Modified Cash Basis Right for You?
In case you are a small business owner that wants much more visibility in your finances with no complete accrual accounting, modified cash basis could be for you. It is simple, affordable and also gives you a better grip on your long-term assets & liabilities while making regular transactions simple to handle.
But in case your business requires audited financial statements or conforms to particular regulatory requirements, modified cash basis might not be for you. However for people that do not have such needs, it is a flexible approach which can save time and produce better financial reporting.
Still unsure? Consult The Fino Partners for expert accounting and bookkeeping services for support on all things accounting.
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