Cash vs. Accruals – knowing your options.
Business owners with an annual turnover of under $2 million per year, have a choice whether to report their GST using a ‘cash’ or ‘accrual’ method. This can result in substantial differences in respect to Quarterly GST and annual Income Tax refunds / payments.
What Is the Difference between Cash & Accruals Accounting?
Cash accounting is recognising the income and expenses in your business when they are physically paid rather than on receipt or issue of an invoice. Many business owners when starting out often use a simple, basic cash system, because it helps to keep track of cash flow.
An accrual accounting system recognises both income and expenses on receipt of an invoice or bill although not yet due for payment. This system will create debtors and creditors in your accounting software, showing what you owe and when, as well as funds owed to the business from your customers.
The benefits of accrual accounting
For small businesses in many industries (like the construction industry for example) there are strong benefits of reporting using an accrual basis. One example is that the cash may not be received in the month that the work is performed which can lead to fluctuating profitability (something that does not look good to either the bank or the ATO). Accrual accounting also assists small business to flatten out the profit, reflecting a more stable and secure business. Accrual accounting also highlights the cash-flow effects of collecting debtors and paying creditors.
The benefits of cash accounting
On the contrary, the benefits to cash accounting are simple to explain – If cash comes in for services performed – we record this as revenue, if cash goes out for goods or services we purchased – we record this as an expense. The cash method of accounting is very simple to administer.
Implications of accruals for GST
How you choose to register for GST may greatly affect the cash flow of your business, as GST is payable on sales for which payment has not yet been received, this could leave you out of pocket for a time. However, GST can also be claimed on unpaid expenses if you hold a tax invoice.
Whether you’ve registered for GST on a cash or accrual basis will also affect your financing of large purchases for your business. With accruals, GST is claimable upfront, so it might be of benefit to your business to use this method.
The method used to report your GST, is of course something that we will review & advice you on.
This has been a touchy subject for the Australian Taxation Office & the courts over the years and there is now a large amount of laws that apply to this subject. When preparing your Income Tax Return, we complementarily review your business situation & ensure you are using the correct method.
Would you like to know more?
I encourage you to contact me on 0404 935 495 or [email protected] for a further discussion about your personal situation.