Accrual vs Cash Accounting
Psst... You should be using accrual!
For any business, keeping track of the financials is crucial for success. While cost accounting or cash accounting may make sense to many business owners, if you own an e-commerce business, you should run your books using accrual accounting. Yes -- cash basis is much simpler and easier to track, but accrual will give you the tools your business needs, to run a smooth behind-the-scenes financial tracking system.
So, what is accrual basis accounting? Using accrual accounting, revenue, and expenses are recognized when earned or incurred, regardless of when cash is received or paid. This method differs from cash basis, which focuses on recording the sale or expense when the cash is in hand or paid out (think about your bank transactions here!).
Now to the critical part -- Why am I claiming the importance of accrual accounting for e-commerce businesses?
Here are a few reasons:
Accurate financial reporting
Accrual basis accounting records the transition of monies when a sale is earned or when an expense occurs. A great example of this would be the purchase of a yearly subscription. Rather than recognizing that expense in total (as you would on the purchase date when using cash accounting), you realize the monthly value of that subscription when it is used. So, using this example, if you purchased a subscription for $120 in January, you would recognize that expense over 12 months at $10/month. Why would you want to do this? Accurate representation. Cash basis financials can easily be skewed and manipulated. Using an accrual basis, you will better understand the actual monthly operational costs, the correct COGS to sell your products, and a better idea of your debts. Those are easy examples -- the critical point is accurate records = more informed decisions to implement financial strategy.
For most e-commerce businesses, inventory is likely your largest asset. The accrual basis allows you to accurately track inventory costs and changes in inventory valuation and will enable you to appropriately track your quantity on hand vs. sold to ensure you are ordering correctly to restock.
Complying with accounting standards
Accrual accounting follows GAAP (generally accepted accounting principles or international financial reporting standards (IFRS). If you plan to obtain future funding or go public, you must comply with these standards.
Enhanced financial reporting and insights on financial health
Accrual accounting accurately depicts an e-commerce business's financial health, allowing business owners, investors, and creditors to assess the company's liquidity, solvency, and overall financial stability. This information is crucial for making strategic decisions and evaluating the business's long-term viability.
In conclusion, while cash basis accounting may seem more straightforward for e-commerce businesses, accrual-basis accounting offers several benefits that can help you better manage your finances, inventory, compliance, and financial health. Accrual basis accounting will give you a more accurate picture of your business's financial health and help you make more informed decisions about your business's growth and financial strategy.
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