Petty cash, also known as cash on hand, refers to small amounts of cash kept on hand in a business. (The term "petty" comes from "petite," or "small.")There are two reasons to keep petty cash:
- To make change for customers or patients
- To reimburse employees for items they have bought for your business
- To pay for small purchases which require cash, such as food for the office lunch or coffee supplies, or for parking. Most retail businesses keep a cash drawer as do healthcare practices.
Petty cash works on the imprest system, in which there is an initial amount of money put into an account, which is drawn upon for a specific purpose (in this case, petty cash). When the account goes below a certain specified amount, the system is replenished.
In businesses that have a frequent need for petty cash, it's often set up in the front office with a petty cash drawer or box, or in a retail location using a cash register. (Yes, some places still use a cash register.)
Because the cash economy is getting smaller, and people are using debit and credit cards more for small purchases, the use of a petty cash system (with a "cash drawer") has diminished. But it's still essential for any business to make sure you account for all small purchases so that you can deduct them as business expenses.
How a Petty Cash System Works
To set up a petty cash system, the initial amount of money comes from the business checking account.
Employees take money from the petty cash account, recording each transaction with date, amount, vendor (who was paid), and business purpose.
Every purchase using petty cash must be documented in the same way as other business income and expenses. Using a petty cash log or petty cash slips will help capture these expenses so they can be used to offset income for business tax purposes.
Someone must check the account periodically so the balance doesn't get too low. When the petty cash drawer gets below a pre-set amount that you determine, add to the drawer by writing a check to "Petty Cash" and cashing that check.
If you use the petty cash account to make change for customers, you will need to do a mini-audit at the end of each day. Start with beginning balance, cash in, cash out compared to transactions, and ending cash.
Setting Up a Petty Cash Account
Start by deciding how much money you will need each day, both to make change for customers and to make small cash payments.
Keep as much cash as you need in your cash drawer, but not too much, so it isn't a temptation for employees or robbers. To determine a maximum amount for petty cash, keep records on expenditures over a period of time, using an average amount for each week, for example. You will need those records for tax purposes too.
Keep Track of Petty Cash Transactions
As you start out, keep track of how much is in the petty cash box or drawer at the beginning of each day. As you make each payment, you will need petty cash slips or a transaction list. For each transaction, record the date, the amount, and what it was for.
Be as specific as possible, so there is no doubt that the transaction was business-related. You don't need to keep track of change each day. But at the end of each day, record the amount in the petty cash drawer. The difference should tally with cash payments made by customers and with the total of petty cash expenses paid from the drawer.
Set Up Petty Cash Policies
Before you start using petty cash, add a petty cash policy section to your employee policies and procedures manual. Include these items in the policy, and consider how you can reduce the risk of employee or customer theft.
- How much should we keep in the account? What is the minimum (when should money be added?) What account should be used to replenish the account?
- Who is in charge of recording transactions? Who puts money back in the account?
- Where is the petty cash kept?
- How are petty cash transactions recorded? Where are the records kept? Who is responsible for adding the petty cash records to your business accounting system?
Petty cash is easy to steal, so make sure you protect it:
- Separate duties, so the person who is recording transactions is different from the person putting the transactions into your accounting system.
- Keep the petty cash box in a secure location, known only to one or two people.
- Do occasional audits, checking to see that transactions are legitimate.
Petty Cash and Taxes
The most important part of a petty cash system is the documentation of each transaction. Documenting transactions is the way a business documents business expenses for tax purposes. By keeping track of all petty cash transactions - no matter how petty- you have records to back up deductions for those small business expenses.
The more documented petty cash expenses, the more your deductions, and the lower your business tax bill.