Calculating Accounts Receivable: Cash Method vs. Accrual Method

When it comes to financial management, knowing how your business will record payments and expenses is the cornerstone of every transaction. Without this essential bit of information, you can kiss even partially-accurate cash flow projections goodbye.

There are two main accounting methods: the cash basis method and accrual accounting. And it isn’t always easy to decide which one to use, especially for new business owners or accounting professionals watching the company scale.

There are different pros and cons to each one. But before we can jump into which method is best for which business, let’s define the terms.

The Cash and Accrual Methods Compared

First off, let's define the key difference between these two methods:

• Cash Basis Accounting records payments when they are received and expenses when they are paid. For example, if you invoice in May and are paid in July, you record the payment as July income.
• Accrual Basis Accounting records payments and expenses when they are billed and earned. If you invoice in May, you record it as income for that month.

The difference between these two accounting methods may seem small, but it can significantly impact cash flow projects and compliance. Regulated by the Financial Accounting Standards Board, the Generally Accepted Accounting Principles (GAAP) dictate that businesses earning more than $25 million in revenue should use accrual basis accounting.

Which is Better: Cash Method or Accrual Method

When it comes to choosing the best accounting method, the truth is that it may depend more on your organization than the method itself. For example, while many businesses and accounting professionals consider the accrual accounting method to be more accurate and transparent in the long term, cash basis accounting offers insight into real-time cash flow.

Generally, accrual accounting is incredibly popular as it offers a clearcut way to manage the books. Accrual accounting also is easier to scale.

Sure, with the cash basis method, you see your cash flow in real-time with each deposit or credit on your business bank account. But in reality, keeping up with real-time payments and expenses manually is incredibly exhausting and challenging. As your business grows, it's easy for mistakes to slip into your balance sheet. The main benefit tends to stem from tax purposes. With the cash basis method, since you don't record a payment or expense until it actually occurs, you may end up shifting income or expenses to a different tax period.

While cash accounting might be a more straightforward financial management strategy for startups, freelancers, or new businesses, at some point, it makes more sense to switch to accrual-based accounting.

Deciding the Right Method for Your Business

Generally, which accounting method makes sense for your organization hinges on your payments strategy. Here are some examples:

• Companies that only work with cash transactions tend to use the cash basis accounting method.
• Entrepreneurs, startups, freelancers, and new businesses tend to use cash accounting to simplify the process.
• Businesses that need to reconcile bank accounts and deal with multiple payment methods typically use accrual accounting.
• Organizations with multiple products or subsidiaries tend to use accrual accounting principles to streamline accounting and manage cash flow.

According to the GAAP, businesses should use the accrual accounting method if they:

• Reach $25 million in revenue within three years or
• Is publicly traded

Suppose you decide to invest in the accrual method of financial management. In that case, you typically need to set up an accounts receivable (AR) and accounts payable (AP) system to ensure that accounting principles are met and overdue invoices are followed-up on.

Calculating Accounts Receivable

For accrual-based accounting, you will need to also calculate accounts receivables and how well you are collecting payments. To do this, simply:

1. Add up all the credit customers owe the company over a given period.
2. Average the amount.
3. Subtract sales allowances and returns you’ve made from the credit.
4. Divide this credit by the average receivables.
5. Divide 365 by this number to understand how many days, on average, it takes to collect payment.

In many cases, accounts receivable software will calculate this information and more for you.

Seamless Accounting with Paystand

Even when adhering to accounting principles, the accounts receivable department is often bursting with time-consuming manual processes. As a result, finance professionals need more than an ERP for clean recordkeeping and fast payments.

Payment automation, including digitizing checks through Smart Lockbox programs, is key to keeping the balance sheets as transparent as possible. As the Venmo of B2B transactions, Paystand provides an end-to-end payments platform that eliminates cash flow bottlenecks, offers profound insight into payment data, and significantly speeds up the collections process.

Our platform can be synced with all major ERP systems to make matters easier. Customers leverage a suite of payment features to cut costs and day sales outstanding, including:

• “Pay Now” functionality
• Scheduled and automated payments
• Convenience and zero-fee payment options for customers
• Certified payment receipts
• Auto-reconciliation
• Deep data and enhanced analytics
• Save customer payment data securely with tokenization
• Add new revenue streams with mark-up options

To learn more about optimizing and automating your accounts receivable, get your free copy of our eBook, 10 Benefits of an Accounts Receivable Platform.