What is Petty Cash and How to Manage it?

Introduction

In the world of business transactions, every dollar count matters. Enter petty cash – the underdog of financial fluidity. In layman’s terms, petty cash is a small amount for impromptu small expenses. In this blog, we’ll unravel the significance of petty cash, exploring its role and management and why this seemingly modest cash reserve plays a vital part in the day-to-day operations of businesses, both big and small. 

What is Petty Cash?

Petty cash is a small amount kept handy in organizations to pay off small-scale expenditures. Petty cash funds are kept in corporations’ drawers or boxes for emergencies, office lunches, flowers, stationary requirements, etc.

The petty cash fund goes through periodic reconciliations, and these transactions are also recorded in financial statements. In enterprises, each department may have its petty cash fund allocated.

The petty cash balance sheet is also classified under current assets in the balance sheet due to its high liquidity. As assets are ordered by liquidity, petty cash, being easily accessible, is positioned near the top of the petty cash sheet.

Why do businesses need petty cash?

Petty cash is a must for most businesses due to its convenience. A petty cash fund aims to offer business units enough cash for minor expenses, streamlining the reimbursement process for staff and visitors.

Consider a typical petty cash example: your office urgently needs A4 paper, and work is at a standstill. Would you opt for a formal request, inventory check, verification, and invoice creation, or a swift solution like withdrawing $5 from the drawer for two bundles of paper? The latter is often the preferred choice, allowing easy reimbursement by presenting the invoice.

Advantages & Disadvantages of Petty Cash

The advantages of Petty Cash are unmatched and cannot be disregarded. Cash is often the quickest, simplest, most straightforward way to pay for things. In impromptu scenarios, they come in super handy. On the other hand, as this cash is readily available, it does raise suspicion about cash security and theft. Sometimes, these bills are untraceable, which causes unwanted errors in the bookkeeping process.

There are many other differences like:

Examples of Petty Cash

Office supplies, like pens, notepads, and paper clips, fall under petty cash examples. Refreshments like beverages, snacks, transportation costs, or cab fares for employees also fall under the umbrella. It covers postage and handling office repairs and maintenance services. Petty cash may be used for small celebrations or events as well.

What is Petty Cash Management?

Petty cash management is a vital record-keeping system for tracking daily small business operational expenses. Often, imprest systems commence with a fixed amount and are replenished as funds diminish, ensuring efficient handling of minor expenditures during daily operations.

A robust petty cash management system is integral for companies to guarantee the appropriate use and documentation of funds. This system is an internal control, fortifying the business against potential theft and fraud risks.

Additionally, it is pivotal in supporting the broader general ledger reconciliation process, contributing to overall financial accuracy and integrity. With controls and transparent transaction documentation, businesses can uphold financial accountability and safeguard their assets efficiently and systematically.

How Does Petty Cash Management Work?

Businesses allocate a specific petty cash amount, adjusting it as needed, typically ranging from $100 to $1000. When initiating the fund, record a debit to the petty cash account and a credit to the bank account in the general ledger. For instance, a $200 withdrawal for petty cash involves noting the funds’ purpose. 

When employees have small expenses, they present receipts to a designated cashier, who logs them in a petty cash book or spreadsheet and reimburses them. Alternatively, the cashier may directly provide funds, requiring the employee to return the receipt.

When replenishing the petty cash fund, the cashier ensures accurate balances of receipts in the petty cash book. Subsequently, they forward these records to the bookkeeper or accounting team, who supplement the fund with additional cash from the bank. The cashier then updates the petty cash book to reflect the revised balance.

The automated accounting system updates the general ledger, if not the accounting team. They note that cash has been taken out of the bank account and added to the petty cash fund, and they also record the petty cash receipts to the correct expense accounts.

For solo entrepreneurs or those with a small team, you’ll likely manage everything independently – distributing cash, collecting receipts, maintaining the petty cash book, and personally handling bank visits for additional cash and accounting updates.

Quick read: Everything You Need to Know About Automated Bookkeeping

How to Set up a Petty Cash Management System 

Establishing an effective petty cash system involves critical elements:

• Appointing a dedicated custodian
• Securing a funding source
• Implementing policies and procedures for expense management
• Incorporating accounting procedures for seamless reconciliation

Step 1: Custodian appointment

Initiating the imprest system begins with appointing a petty cash custodian. This individual, primarily accountable for managing petty cash, enhances accountability and minimizes error or fraud risks by restricting access.

Step 2: Funding account

The imprest system assigns a predetermined balance to the petty cash fund from the company’s checking account. This balance, reflective of expected activity, ensures adequacy and aligns with the company’s size.

Step 3: Secure funds

Once the cash has been released to the petty cash fund, you will likely want to secure it in a lock box, safe, or a locked drawer or file cabinet. Only the custodian and other specifically designated individuals, such as the CFO, may possess the key. This helps ensure accountability and protects against theft or fraud.

Source: PwC report of CFO and Finance Leaders — Managing business risks. 

Step 4: Policy establishment

Implementing policies is crucial for dictating the spending and administration of petty cash funds. These policies define qualifying transactions, providing guidelines for properly documenting business expenses within the established framework.

Step 5: Record disbursement

To administer the petty cash account effectively, the custodian must maintain a disbursement log. This log facilitates accurate reconciliation when preparing financial statements at the reporting period’s end.

Step 6: Receipt requirement

Alongside a disbursement log, company policies should mandate receipts for every purchase. Detailed vendor or cash register receipts, specifying items, dates, and amounts, are crucial—petty cash vouchers further document transactions, including expense purposes, account details, and the responsible individual.

Step 7: Monitor Spending

The custodian initiates a bank check request to restore the petty cash to its original balance, with a reconciliation of receipts and spending preceding replenishment. Close monitoring involves regular tallies, verification of receipts, and reconciliation by a separate entity to uphold the segregation of duties and ensure compliance with company policies.

Quick read: 7 Common Accounting Errors & How AI Detects Them (With Examples)

9 Challenges with Petty Cash Management

Source: Hubspot survey 2019 – Travel & expense management trends reports

1. Poor documentation process

   A significant challenge in the process is inadequate documentation. With petty cash slips, verifying expenses and reconciling records becomes easier, risking inaccuracies in accounting.

2. Flawed recording accuracy

   Accurate recording of petty cash transactions is crucial for reliable financial records. Errors can disrupt reconciliation, impacting the system’s effectiveness.

3. Reconciliation struggles

   Petty cash reconciliation is challenging in larger organizations, demanding meticulous attention to balance physical cash with recorded expenses for accuracy.

   Automated reconciliation software is a tool that can be used for efficient petty cash management. By utilizing reconciliation templates, users can systematically compare general ledger (GL) entries with supporting balances related to petty cash transactions. This streamlines the process of verifying and managing open items, ensuring accuracy in accounting.

4. Security and approvals

   Securing petty cash presents an ongoing challenge, demanding protective measures to prevent theft or mishandling and ensure the cash’s safety.

5. Technology dependency

   Incorporating technology into petty cash accounting can prove challenging, particularly for businesses accustomed to manual processes.

6. Slow replenishment time

   Timely replenishment of the petty cash fund is vital, preventing operational disruptions and maintaining consistency in financial records.

7. Lack of transparency

   Producing precise and transparent reports for petty cash transactions poses challenges, particularly in manual accounting systems.

8. Handling foreign currency

   Managing petty cash in foreign currencies for international transactions introduces complexity, with fluctuating exchange rates and potential currency-related discrepancies demanding meticulous attention.

9. Avoiding overuse

   Preventing the risk of overusing petty cash for unauthorized expenses requires clear usage guidelines and consistent monitoring to maintain financial control.

Establishing Internal Controls for Petty Cash Management

Creating, maintaining, and enforcing a robust petty cash management system establishes vital internal controls. This ensures accurate recording, reconciliation, and visibility into expenditures. While individual amounts may seem small, cumulatively, they impact financial statements. 

Safeguarding petty cash, segregating duties, and monthly reconciliation are crucial controls for effective management. Consistent adherence to these practices enhances financial accuracy and transparency, preventing loss of deductions and providing a clear understanding of resource allocation within companies, regardless of their size.

Quick read: 6 Best Practices for Maintaining Accounting Accuracy

Role of Automation in Petty Cash Management

HighRadius’ automated accounting software offers a comprehensive solution for efficient cash management. The account reconciliation function ensures accurate tracking of petty cash transactions, reconciling invoices, and maintaining a precise balance sheet. Financial close capabilities expedite bookkeeping processes, allowing for faster closure of books. Anomaly management identifies errors and omissions, enhancing accuracy.

For handling petty cash in daily accounting, users can utilize the reconciliation feature to track every transaction, ensuring transparency. Financial close streamlines the recording of petty cash activities, and anomaly management helps detect discrepancies promptly. These tools bring automation and precision to managing small cash amounts in accountants’ daily routines.

FAQ

1) What type of account is petty cash?

Petty cash is classified as a current asset on the balance sheet. It represents a cash reserve maintained by a business to cover minor expenses. While it’s a liquid asset, it’s subject to internal controls and requires proper management and documentation to ensure accurate accounting and reporting

2) What are the rules for petty cash?

Petty cash rules entail designating a custodian responsible for fund management, setting a limit for disbursements, requiring receipts for all expenses, and conducting regular reconciliations. And, petty cash usage should be restricted to authorized business-related expenses only.

3) What is the limit of petty cash?

Petty cash ranges from ₹5,000 to ₹20,000, adjusted based on branch size and transaction frequency. Designate a cashier and custodian to manage the fund effectively.

4) What are the types of petty cash?

General Petty Cash covers miscellaneous expenses like office supplies. Imprest Petty Cash is replenished regularly. Emergency Petty Cash is reserved for unforeseen circumstances. Each serves specific purposes for efficient fund management.

5) Is petty cash an asset or capital?

Petty cash is classified as a current asset, represented as a debit on the balance sheet, highlighting its immediate availability for small, routine expenditures within an organization’s financial structure.