Sole Proprietorship Accrual Vs.

Cash
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by Devra Gartenstein

Every business, including a sole proprietorship, must base its bookkeeping conventions on
the money that flows into the company during a given period, or on the value of business
transacted that may or may not be paid immediately. The finances of a sole proprietorship
are inextricably tied up with the finances of its owner, so this accounting decision can have
ramifications for money management and taxes, affecting the owner's personal finances as
well as those of the business.

Cash Flow
The decision to use the cash method of accounting ensures that the company's books will
reasonably effectively reflect its cash flow situation. This is particularly important for a sole
proprietorship, where cash flow shortfalls must often be supplemented using personal
resources or individual credit. A sole proprietor using the accrual method of accounting
should be aware of the fact that the amounts reflected in her sales records don't accurately
reflect her liquid cash on hand, and she should have contingency plans for financing day to
day operations.

Cash Draws
The cash method of accounting is based on the sums that a sole proprietorship collects from
customers as they are collected. These sums directly translate into revenue that is available
for the sole proprietor to either withdraw from the business or retain in business accounts as
operating capital. The accrual method of accounting reflects transactions that may not have
been already paid. Because accrued sales may still be outstanding, these revenue amounts
aren't necessarily available to a sole proprietor for an owner's draw.

Equity
Regardless of whether a sole proprietorship uses the cash or accrual method of accounting,
the sales it transacts will increase its owner's equity. If the business records sales as it
receives payment for each transaction, each recorded transaction represents revenue that it
already has on hand. If the business records sales as they're made, the sale counts as an
asset on the owner's balance sheet either as cash on hand or as accounts receivable, which
will be paid down the line.

Taxes

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The decision of whether to use the cash or accrual method of accounting may affect the
amount of a sole proprietor's tax liability during a given year, although it is unlikely to affect
her tax burden long term. If she uses the cash method, she'll not be liable for taxes on
transactions that occurred during the calendar year but weren't paid until after the year
ended. If she uses the accrual method, her gross revenue figures include all sales, whether
or not they've been paid.

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