Ever wondered how businesses keep track of their money? They use something called “cash accounts.” These accounts are super important because they help businesses stay organized, manage their money, and pay for things on time.
Today we’re going to explain what cash accounts are, discuss different types of accounts and offer examples that make everything clear. By the time we’ve finished talking about cash accounts and their role in supporting business operations efficiently.
What Are Cash Accounts?
Cash accounts serve as digital piggy banks for businesses, recording every time money comes or goes out and is tracked in this account. They allow business to know at all times exactly how much cash is in their coffers at any one point in time.
Cash accounts offer businesses something special-they cannot borrow money with them like they can with some other accounts, ensuring that any spending must come directly out of what’s already there and keep expenses manageable. This makes sure no more is spent than is budgeted and simplifies financial affairs overall.
For example, If a company purchases supplies worth $500, that amount will automatically be deducted from its cash account; conversely if they sell goods worth $1,000 they gain another $200 into it.
Now that we understand what cash accounts are, let’s examine some of their various forms.
Types of Cash Accounts
Businesses utilise various cash accounts for different tasks and expenses, like having separate jars for specific expenses.
1. Payroll Checking Account
This account is specifically used to pay employees. Instead of mixing payroll money with other funds, businesses keep it in a special payroll account.
Example:
Imagine a company owes its workers $20,000 for the month. Before payday, the company transfers exactly $20,000 into the payroll checking account. Then, each paycheck is sent from this account. By doing this, the business ensures workers are paid correctly and on time.
2. Operating Checking Account
This is the main account businesses use for everyday activities. It’s where they deposit money they earn and pay for things like rent, electricity, and office supplies.
Example:
A store which sells $500 of products will have that money go straight into their operating account, then later when paying their electricity bill (e.g. $200), will come out of that same account.
3. Merchant Account
Merchant accounts are created specifically to process credit and debit card payments, making it possible for businesses to accept customer payments using this payment option.
Example:
If you purchase an item for $15 using credit, your payment goes first to a merchant account before being transferred into its primary operating account for processing and then transferred back out again to you as cash back.
4. Petty Cash Account
Petty cash accounts provide for small, everyday expenses like coffee purchases or office supplies. Businesses should maintain this fund to cover such purchases.
Example:
Imagine an employee needs $10 from the petty cash account for markers needed at a meeting; at the end of each day they add receipts as evidence that everything has been properly tracked – in other words if there was $100 originally in there there should now be $90 cash and one receipt left over from whence this money came.
5. Sweep Account
An enterprise sweep account helps companies maximize the return from their money. Any excess funds left over at day’s end in their main bank are “swept” into this account to earn interest or invest, meaning your extra capital won’t just sit idle.
Example:
Let’s say a company finds itself with an extra $5,000 sitting in its operating account, this funds would be moved overnight into savings or investment accounts and over time earn interest as it grows.
Accounts such as these help businesses stay organized and ensure their money is spent wisely.
Cash Accounting Examples
Cash accounting is a simple way of recording money. Businesses write down when money is actually received or spent, not when a promise of payment is made. Here are more detailed examples to help you understand:
Example 1:
Imagine Company A sells five computers to a school for $10,000 on January 1. The school pays for the computers on January 10. Using cash accounting, Company A will record the $10,000 on January 10, not on January 1. Why? Because that’s the day they actually received the money.
Example 2:
Company B provides pest control services on March 15. The customer doesn’t pay the $500 bill until April 1. With cash accounting, Company B won’t record the $500 until April 1, when the payment is finally made.
This system works great because it shows businesses how much actual cash they have at any moment. But it also has its drawbacks, as we’ll see later.
Why Are Cash Accounts Important?
Cash accounts may seem simple, but they play a big role in keeping businesses successful. Here’s why they matter so much:
Advantages of Cash Accounts
- Easy to Track Money: Cash accounts are like a tracker that tells businesses exactly how much money they have. Because it’s so simple, businesses don’t have to deal with complicated calculations.
- Helps With Budgeting: Since businesses can only spend what they have, cash accounts help them stay within their budget. This reduces the risk of overspending.
- Great for Small Businesses: Small businesses and startups often use cash accounting because it’s easy to manage and understand.
Example of Advantage:
A bakery uses a cash account to track its sales and expenses. By checking the account, the owner can see they made $2,000 last week and spent $1,500 on ingredients, leaving them with $500 in profit. This simple system makes their finances clear and easy to follow.
Disadvantages of Cash Accounts
- Might Not Show the Full Picture: One downside is that cash accounts don’t show money a business is owed or needs to pay in the future. This can make a business look like it has more money than it actually does.
Example of Disadvantage:
A clothing store has $3,000 in its cash account. But they also owe $1,200 for a new shipment of jeans. If the jeans haven’t been paid for yet, the cash account won’t reflect that, making the business seem like it has more money than it does.
- Not Always Accurate in the Short Term: If a business has recently spent a lot of money on supplies but hasn’t received payments from customers, it may seem less successful than it really is.
- Tax Complications: Cash accounting can sometimes cause tax issues. For example, if a business receives a big payment at the start of the year for work done in the previous year, it can confuse their financial records and impact taxes.
Example of Tax Complication:
A construction company finishes a project in December but doesn’t get paid $15,000 until January. They can only report that income for the new tax year, even though the work was done earlier. This delay can make their tax records look odd.
Final Thoughts
Cash accounts are essential tools for efficiently running any business. From paying employees, covering expenses or earning interest with funds that remain unspent – cash accounts provide businesses with an accurate snapshot of their financial health. Understanding cash accounting provides businesses with insight into what happens behind the numbers.
Although these accounts come with some downsides, their benefits make them an appealing option for small businesses. By managing cash properly and preventing overspending while budgeting more effectively and planning long-term success more easily.
Now that you understand cash accounts, it should become evident just how essential they are in keeping a business running efficiently!
