Cash versus Accrual Accounting: The Effect on Your Cashflow
One of the privileges the ATO affords “small businesses” is the option to report for GST on either a cash or accrual basis. Last month the Senate finally passed tax legislation related to the 2016 budget. One of the most significant changes is the move to redefine small business from one with a turnover up to $2million to one up to $10million.
This means that businesses with turnover between $2 and $10million are suddenly blessed with a host of small business tax breaks – one being the ability to choose how they report for GST.
With all the other goodies involved in being reclassified as a small business, many business owners may ignore the importance of the cash versus accrual decision. The method you choose can have a significant impact on your cash flow and it’s important to understand this and make a wise decision.
What’s the difference?
Using a cash accounting method requires you to report income and expenditure as the actual cash is received or paid. The accrual method instead recognises transactions at the time of invoice, ignoring the flow of cash in and out of your bank account.
Aligning GST to cash flow.
The cash accounting method most closely aligns GST payments with the actual flow of money. So it is probably safest from a cash flow perspective. However, the best option for your specific business may depend on your trading terms and the size of your purchases.
Paying GST on income before you get the cash.
If your trading terms tend to stretch beyond thirty days, then reporting on an accrual basis means you are paying the tax man before you get paid yourself.
If your business tends to carry high accounts receivable with extended trading terms then your cash flow may be better off using the cash accounting method.
Claiming GST upfront on unpaid expenses.
If you make large purchases, then reporting on an accrual basis allows you to claim the GST as soon as you get the invoice. You don’t need to wait until the bill is actually paid.
If your business regularly makes sizeable purchases then there may be cash flow advantages to accrual reporting.
Talk to your accountant
We recommend that all small business owners – especially those who have been newly classified by the ATO as a “small business” – consider the cash flow implications of the options for reporting GST. Before making a decision to change, talk to your accountant to ensure that all implications are considered.
As well as deciding on your GST reporting method, it is also time to start tax planning. Download our free eBook Keep More Money in Your Pocket which outlines all the key tax planning strategies used by small business.