Accounting is a process to identify, measure, and communicate the business economic information in a financial record for decision making and tax returns purposes. Accrual Accounting and Cash Accounting are two commonly used methods. A small business, which renders service and generated revenue of less than 5 million annually, will meet the IRS qualification that allows the small business owner to elect either one of the two accounting methods.
There are many excellent online articles written by CPAs on the advantages and disadvantages of either accounting method. I noted some CPAs were advocating the Accrual Accounting as being superior from the accounting standpoint. As a sole proprietorship owner of a dental practice for many years, I see Cash Accounting should be the choice of accounting for the small medical/dental practice and other service type businesses.
(1) Cash Accounting is simple and intuitive. Nowadays, a simple bookkeeping software program can track all business transactions without the need of a bookkeeper. One only needs to record all daily transactions such as receipts (income) and written checks (expense). The program can display monthly balance sheet and streamline the tax preparation process at the year-end by exporting data to a tax preparation software.
(2) Accrual Accounting is a high maintenance system, which means a higher business expense for professional accounting service. Accrual Accounting has both Account Receivable and Account Payable entries, which have to be meticulously reconciled periodically to reflect the actually financial events. And those two numbers have to be monitored constantly by the business owner.
(3) In a medical or dental practice that accepts popular insurances, Account Receivable receipts are from both individual patients or insurance companies. I have learned that patients who do not take care their bills within first 30 days of billing are likely to be delinquent. Health insurance companies sometimes dragging their feet for more documentation, but they will pay those claims under lower contacted benefits in two or three months. Therefore, the practice books a fantastic revenue in Accrual Accounting will have a false sense of great revenue numbers, but is subjected to massive write off of the Account Receivable later due to the reality of the low patients collection and insurance company low reimbursement rates.
I am a strong believer of KISS (Keep it Simple, Stupid) principle. It is not surprising that most small businesses have elected Cash Accounting as their choice. However, Cash Accounting has the drawback of unable foreseeing future income and expense cash flows. Knowing his unique business situation, one should seek professional advice on the best option for the accounting method.