We’ve all heard “cash is king.” That’s especially true in these trying times when businesses are dealing with a sudden and unprecedented drop in revenue. Those small businesses deemed “non-essential” have had to find new ways to drive enough revenue to survive. For many small businesses, this means asking loyal customers to purchase gift cards.
This move, and the overwhelming support of those loyal customers, is helping small businesses in ways we’ve never imagined, giving them a lifeline to the cash they need to operate. Yet, offering gift cards to your customers brings with it some accounting intricacies you’ll want to be sure to follow to maintain the accuracy of your financial statements.
How to Recognize Gift Cards: Accrual vs. Cash Accounting
Depending on whether you use accrual or cash basis accounting, you’ll process your gift card sales information differently.
As a quick refresher, cash basis accounting means that you recognize income and expenses as soon as money changes hands. Accrual basis accounting means that you recognize that money when the work has been done, regardless of when cash changed hands.
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Using Cash Basis Accounting
If you use cash basis accounting, you simply list the cash coming in from gift cards as sales just like any other. You’ll want to keep track of how many gift cards you’ve sold for liability purposes, but you probably aren’t going to be interested in robust reporting capabilities that businesses using accrual basis accounting will need. Lucky for you, the process is pretty straightforward.
Using Accrual Basis Accounting
If your business uses accrual basis accounting, you’ll need to track gift cards a little bit more carefully.
When a customer purchases a gift card from you, you receive money from the customer but you haven’t provided a good or service yet. Because you haven’t provided anything in exchange for their money, this is a liability to your business.
Remember the accounting equation? It says that Assets = Liabilities + Equity, and it’s the basis for your balance sheet. Here’s an easy way to think about each category:
- Assets: Everything your company possesses.
- Liabilities: Everything your company owes someone else.
- Equity: Everything your company owns.
If you own a bakery and someone purchased a $20 gift card from you, you possess their $20 bill (an asset) but you owe them a cake (a liability).
In other words, a customer will return to your business to use the gift card, and you’ll need to be ready to provide your goods and services at that time. Because of this, you’ll delay counting the purchase as revenue until the gift card is redeemed—even though you have access to the cash it generated.
Tracking Gift Cards in Your Accounting File
Gift cards and gift card purchases can artificially inflate your sales numbers, so you’ll want to keep them separate from your other sales for analysis and reporting purposes. The good news is that if you are using a system like Shopify or Square, they do the heavy lifting here by separating and tracking your gift card sales automatically.
If you don’t use Shopify or Square, you’ll need to record this process in your accounting file with a debit to your Cash account and a credit to a Liability account. Again, you should track these separately for analysis and reporting purposes, so you should create a separate liability account for them (like a sub-folder). To keep it simple, call it something like Gift Cards. This sale does not count towards your revenue yet, because it is a gift card liability until the card is used. At that point, your revenue is recorded and counts as a transaction sale.
|Gift Card – Liability||$20|
You can use a spreadsheet to track these gift cards but make sure you’re using spreadsheets that are stored in the cloud and not locally on your computer, in the event you need to access the information from anywhere else.
Gift Card Usage And Breakage
In the process of gift card redemption, many customers will spend more money than is on the cards and your business can increase sales this way. The rest of your customers will either never spend the gift card or leave a small amount of money on the gift card that they’ll never use. These unused funds are referred to as “gift card breakage” and can be a benefit to your company.
Alternatively, your business should be aware of unclaimed property laws for your state. Referred to as escheatment laws, these determine when and how a business turns over unclaimed property to the state government. The purpose of these laws is to protect abandoned property, but because of them, your business may need to surrender those unredeemed gift card sales after a certain period of time if your gift cards have an expiration date.
Depending on your state’s laws (find them here), it may be worthwhile for you to periodically remind your customers to use their gift cards. In fact, many customers who use gift cards will spend 38% more than the funds on their gift card.
Benefits of Gift Cards
Gift cards provide an influx of cash for your business while increasing your marketing opportunities. If a customer purchases a gift card and gives it to their friend as a gift, you can now direct your marketing to two people instead of one. They also provide a unique cash flow benefit to your businesses by delaying the exchange of goods in return for payments.
Business owners have so many important things to worry about. Worrying about small accounting details (like gift cards) shouldn’t be one of them. If you’re curious about how to offload your accounting and finance duties request a demo today and let ScaleFactor take care of the rest.
Just looking for some help navigating the COVID-19 crisis? Check out our resource center here.