Most business owners engage the services of an accountant to handle their annual accounts, tax obligations and other regulatory commitments so they can get on with doing what they enjoy, what they’re trained for and what brings in the money – running their business.
While accounting is a specialist profession and many aspects best left to the experts, it can be extremely worthwhile for business owners and decision-makers to have a good understanding of the basics. This is particularly significant when it comes to deciding which type of finance is best suited to a business.
Different commercial finance facilities are suited to the different accounting methods. Understanding why and how the finance type selected can work to deliver taxation and other benefits to your business may be extremely useful and advantageous in managing your business.
To assist you build your knowledge bank, we’re covering off on the basics of the different accounting methods and how each works with the finance products we offer.
Overview of Accounting Methods
There are two popular methods of accounting used by Australian businesses – cash accounting and accruals or non-cash accounting. When establishing a business, the accounting method to be used will be determined. This decision as to which method is based on numerous aspects of the business. The ATO has rulings around when a business may change the method of accounting that they use.
The key difference between these two methods is essentially based on when income and expenditure is accounted for. The method selected may impact when tax obligations are due for payment, the annual accounts including the company’s balance sheet and the profit and loss statement.
Due to impact on the balance sheet, the type of accounting method is a deciding factor when it comes to which finance product is best suited to your business.
- With the cash accounting method, your income is recorded in the accounts at the time it is received.
- With the accruals method, your income is recorded when an invoice is issued to a customer, regardless of if it has been paid.
- With the cash accounting method, expenses and costs are recorded in the accounts on the date that an invoice is paid.
- With the accruals method, expenses and costs are recorded in the accounts on the date that an invoice is received whether or not you have paid it or not.
With the cash method, the business accounts at any one time provide a precise picture of the financial situation – what’s been paid and what’s been received. With the accruals method, the accounts provide a larger scale view of the financial position – what is owed and what is owing.
Managing the accruals method on a day-to-day basis can be more complex than the cash method which is one key reason why especially SMEs tend to use cash accounting.
To implement the accruals method, businesses would usually need to employ a trained financial officer or skilled bookkeeper or leave all the accounts work to their professional accountant. Any of these options involve an additional cost to the business which may be why it is not preferred by smaller enterprises.
The Australian Government website www.business.gov.au provides in-depth information on accounting methods and systems if you would like to learn more.
Finance Products and Accounting
As the two accounting methods have differing treatments of the business balance sheet, they are better suited to different business finance products. When sourcing finance for the acquisition of assets such as cars, plant, equipment, vehicles, trucks etc, the accounting method is a key consideration.
- Cash accounting is best suited to Chattel Mortgage.
- Either the accruals or cash method applies with Commercial Hire Purchase.
- Rent to Own and Leasing suit the non-cash or accruals method.
Balance Sheet Specifics
Getting down to more detail, we look at the balance sheet as this is the key area. Assets and liabilities that are owned/owed by a business are entered on the balance sheet. If an asset is entered on the balance sheet then the asset can be depreciated in line with ATO rulings and the business realise the tax deductions.
With Rent to Own and leasing products, the asset being purchased is actually acquired by the lender and leased/rented back to the borrowing company. These are known as ‘off balance sheet’ finance. The asset – car, truck, equipment – is off the borrower’s balance sheet and on the lender’s balance sheet. This process is considered as ‘improving the balance sheet’. It may improve the balance sheet but it means that the business cannot realise tax benefits of depreciating the asset.
But there are other tax benefits to be realised by Leasing and Rent to Own as the monthly payments are tax deductible.
Chattel Mortgage involves the borrower acquiring the asset so it appears on their balance sheet. The business can then depreciate that asset in line with ATO rulings usually when the end of year accounts and tax return is being prepared. The repayments on Chattel Mortgage are not fully tax deductible but the business receives the tax benefit from depreciation.
So why does it matter which way you go with accounting method or finance product? Benefits can clearly be realised by businesses in all scenarios. However, if businesses are looking to realise the benefits of accelerated depreciation measures as offered on occasions by the Government, then they would need to purchase the asset with a Chattel Mortgage.
Such measures recently offered include the Instant Asset Write-Off and the Business Backed Investment which were introduced as COVID-19 stimulus measures. Governments often use this type of accelerated depreciation measure as part of their investment incentives strategy.
So having this basic understanding of accounting methods will hopefully assist you when sourcing finance for your next asset acquisition.
To request a quote for finance on a car, truck, plant or equipment, contact business.finance.
DISCLAIMER: THE OBJECTIVE OF PROVIDING THE INFORMATION IN THIS ARTICLE IS NOT TO PROVIDE FINANCIAL ADVICE BUT TO PRESENT GENERAL INFORMATION AND DETAILS ON GOVERNMENT POLICIES, FINANCE PRODUCTS, GOODS AND SERVICES AND OTHER TOPICS. NO LIABILITY IS ACCEPTED IN REGARD TO ERRORS IN THE PROVISION OR INTERPRETATION OF SAID INFORMATION. INDIVIDUALS SHOULD CONSULT WITH FINANCIAL ADVISORS IN REGARD TO SPECIFIC DECISIONS AROUND THEIR FINANCE.