Cash vs. Accrual Accounting: Choosing the Right Method for Your Amazon Business
Introduction
Running an Amazon business comes with its fair share of challenges, and managing your finances is undoubtedly one of them. As an Amazon seller, keeping a close eye on your cash flow, sales, and expenses is crucial for maintaining a healthy and profitable business. In this blog post, we will discuss the topic of cash versus accrual accounting and help you choose the right method for your eCommerce business.
Cash vs Accrual - What Are They?
Cash and accrual accounting are methods of recognizing revenues and expenses at different periods of time. Neither is more accurate, though depending on your business model one might be a better fit. They key is to pick one and remain consistent.
Cash Accounting
Cash accounting is a straightforward method of recording financial transactions based on actual cash inflows and outflows. With cash accounting, you record revenue when cash is received and expenses when cash is paid.
For example when you buy 100 widgets at $10 each January 1st, you write that as an expense of $1,000 that day. Same as recognizing Amazon revenue as when you receive their biweekly settlement in your bank account.
This method offers simplicity and ease of use, making it suitable for small or new Amazon businesses. It allows you to track your cash flow in real-time, providing a clear picture of the money coming in and going out of your business.
However, cash accounting has its limitations. It may not provide an accurate representation of your long-term financial health since it doesn’t account for accounts receivable and payable nor accurately depict inventory and sales as they occur.
With that same example above, what if the widgets arrive and sell out all in March- you would see a big expense in January but nothing in March when they sold; this is correct with cash flow for inventory, but doesn’t make a lot of sense for getting a real pulse on your inventory.
Similarly, what if you sold $10,000 of sales December 31st, but don’t get paid until January 5th? Under cash accounting, you wouldn’t record that revenue until you got paid the 5th, but that might not provide the most accurate picture.
Similarly with revenue, if you only get paid once a month, it looks like a lump sum on that date and nothing when sales happen every day. There can be a balance without you needing to record every single transaction when it occurs like accrual, but cash only shows when cash moves hands making it harder to assess your overall financial position.
Accrual Accounting
Accrual accounting, on the other hand, takes into account the revenue and expenses as they are earned or incurred, regardless of when the actual cash transactions occur. This method provides a more accurate representation of your overall financial health by including sales and inventory as they sell as well as accounts receivable and payable. It allows you to track the revenue you’ve earned even if you haven’t received the payment yet.
Back to the initial inventory example of 100 units at $10 each purchased January 1st, under accrual accounting you would record that initial transaction as debit-inventory, credit-payment method (increase inventory, decrease payment account) to show on your balance sheet.
Then, once they start selling- say 10 units in February – you would expense and decrease inventory asset into the COGS expense account of just those units that sold: $10 * 10 units = $100 COGS that month. By the time they sell out, both cash and accrual would show the same total expensed, but cash would not give you the proper snapshot: only sums.
Similarly with revenue, instead of recognizing a sale once its payment happens, accrual does it every time a transaction occurs even if payment is delayed. So with $10,000 sold December 31st but paid January 5th, regardless of cash, accrual would record revenue December 31st.
Accrual accounting is particularly beneficial for businesses with inventory – especially eCommerce companies- or those looking to get a more accurate on the current profitability and balance sheet of the company. Accrual makes it easier to forecast sales and expenses by seeing them as they occur, not just paid.
The drawback is accrual can be slightly more complicated and requires more effort to maintain, but with the right system can unlock all sorts of insights into growing your business.
Cash vs Accrual Inventory Comparison
To view the difference between methods, below is a hypothetical profit and loss of a cash, and accrual company for 6 months.
In this situation, the company purchased 600 widgets @ $10/ unit = $6,000, January 1st. They then sell 100 units/ month @$30 = $3,000 in monthly revenue.
Note how after all units are sold, the total Cost of Goods Sold, and total Profit/Loss is the same.
However, when managing your company, seeing a big $3000 loss one month, and then big profit every month is not as helpful to know truly how profitable you are. Accrual provides the more accurate picture in the day-to-day by properly expensing COGS as they occur, rather than the lump sum cash transaction at the start of the year.
Choosing the Right Method for Your Amazon Business:
When deciding between cash and accrual accounting for your Amazon business, several factors should be considered. Firstly, consider the size and growth potential of your business. If you’re just starting or running a small, seasonal business, cash accounting might be a suitable choice due to its simplicity. However, if you have ambitions for growth or operate a larger-scale eCommerce business, accrual accounting will provide a more comprehensive view of your financial position.
Also, consider your reporting and compliance needs. If you need to provide financial statements to investors, lenders, or other stakeholders, accrual accounting is generally preferred, as it aligns with generally accepted accounting principles (GAAP) and offers more detailed financial reporting.
Especially if you’re just starting out doing less than 10k/ year in revenue or using a spreadsheet to record transactions then cash is going to be fine for you. However, once you do more than 10k/ year or want to see the true picture of your company accrual makes sense; however think carefully because you can’t easily just switch back and forth. Do note that when you switch to accrual, you are generally going to want a real double entry accounting ledger like SellAnalytix, as accounting become more complex than recommended on just a spreadsheet.
Conclusion
In conclusion, the choice between cash and accrual accounting for your Amazon business depends on various factors, including business size, cash flow management requirements, and reporting needs. While cash accounting is simpler and offers real-time cash flow tracking, accrual accounting provides a more accurate representation of your overall financial health and better tracking of accounts receivable and payable. It is crucial to make an informed decision based on your unique business circumstances and consult with accounting professionals to ensure compliance and accurate financial management.