Most customers were using cash basis accounting when they came to us. We’ve switched most to accrual basis accounting and want to clarify how it affects the business, taxes, cash flow, and why most SaaS businesses would benefit from the switch. I know this sounds more mind numbing than watching paint dry but I promise it will pay off (literally).
Consider these 4 questions:
If you answered “YES” to any, you may be able to lower your tax bill this year by switching to accrual accounting
Cash Basis Accounting: your financial statements will be compiled based on when cash comes into and leaves your company.
Accrual Accounting: your financial statements will be compiled based on when revenue is earned and expenses are incurred, regardless of when cash is exchanged. This method of accounting is regulated under GAAP (generally accepted accounting principles).
*Not sure which method you use? - Ask your bookkeeper or tax accountant or check your settings in your accounting software.
Take the following example - It’s November 1st, 2019 and you just closed a $12,000 annual subscription for your SaaS business, paid in full upfront. Congrats! The chart shows how it would be accounted for under the different methods for your tax year ending December 31, 2019.
As you can see, under the cash basis of accounting, you will have recognized $12,000 of revenue related to this subscription in 2019. On accrual basis, you will only recognize $2,000 of revenue in 2019 and defer the remaining $10,000 to be recognized in 2020.
When it comes time to pay your 2019 taxes, under the cash basis of accounting you’ll be paying taxes on $12,000 of income compared to only $2,000 for accrual basis. You don’t have to be a CPA to realize you’ll be saving some serious money in 2019 if you use accrual accounting - and everyone knows a dollar today is worth more than a dollar tomorrow.
Disclaimer: One major downside of accrual accounting is that it does not provide an accurate picture of your current cash balance. If you use accrual accounting, make sure you have a solid cash forecast in place to carefully monitor your cash flow.
If your company will someday raise money or you want to save some cash on this year’s taxes, you might want to make the switch today.
TL:DR If your company is using a cash basis of accounting, sells annual contracts (amount due upfront), experiencing year over year growth and are profitable, you may want to consider switching to accrual (or modified cash) basis of accounting to save money on your taxes this year. Ask us how we can help you with this.