It sure would be nice to have some spare cash around to pay for these small business expenses, wouldn’t it? That’s where petty cash comes in.
What is petty cash?
Petty cash is simply any physical cash your business keeps on hand to pay for small, unplanned expenses. Most businesses won’t keep more than a few hundred dollars in petty cash around. They’ll usually keep it in a lockbox or a cash register, and will have some kind of system in place to make sure none of it gets lost.
What are some typical petty cash expenses?
Most small businesses spend their petty cash on things like:
- Office supplies
- Coffee and snacks
- Fuel and parking for work trips
- Reimbursements to employees for small expenses
- Any other unpredictable expenses that are too small to write a check for
Why do I need a properly set up petty cash fund?
Many small businesses don’t have a formal system for petty cash—owners will simply pay out of pocket for small expenses and hope nothing goes wrong.
This can get confusing and expensive as a company grows: your random expenses become more frequent, and the number of tax-deductible expenses your business makes increases.
The small expenses that your business makes with petty cash might not seem like a big deal, tax-wise. But they can add up. If you average $100 petty cash expenses per month, that’s $1,200 you could potentially write off your tax bill next year!
It might be tempting to wing it for as long as you can, but setting up a proper petty cash system early is crucial.
How does it work?
Most small businesses use the imprest system for their petty cash, which is just a fancy way of saying that the fund starts out at a pre-set amount (say, $200) and is replenished back up to that amount if it falls below a certain threshold (say, $20).
Small businesses will often record all disbursements in a log and put one person in charge of petty cash to make sure none of the funds go missing.
How do I set up a proper petty cash system?
Step 1: Get a lockbox or cash register
You can find these at most office supply stores. Without a physical, dedicated place to keep the petty cash, you’ll probably lose track of it, and/or make so many exceptions to when you use the petty cash that it stops being useful.
Step 2: Choose a petty cash custodian
The petty cash custodian is in charge of managing the petty cash fund. If your business is small enough, this might be you. If you run a nonprofit, this will likely be your treasurer. For slightly larger small businesses, this might be your office administrator.
Why one person? Making a single person responsible for petty cash cuts down on confusion and minimizes the risk of theft.
Step 3: Set an initial amount, a replenishment threshold, and a withdrawal limit
How much petty cash should you keep on hand? That depends on how many small expenses you make and how often you make them, but most businesses seem fine carrying between $100 and $200 in petty cash.
Use your judgement, and put less into the petty cash fund than you think you need—you can always increase the amount later.
Step 4: Go to an ATM, or write a check to petty cash
Let’s say you decide on a petty cash float of $200. The next step is to write a check to petty cash for $200, cash it, and stow it in your cash register or lockbox.
This is the first entry in your petty cash account, represented by the following journal entry that shows petty cash leaving your bank account.
Step 5: Create a petty cash log
You also need a log to keep track of all the expenses you’re making using your petty cash. Here’s what a petty cash log for a typical small business might look like at the end of the month:
Petty Cash Log
For the month of April, 2019
Total cash remaining: $49.15
Top up required: $150.85
Notice how the far right-hand row lists the current balance of the petty cash fund? This lets you reconcile—that’s fancy accounting speak for “double check”—your petty cash fund on the fly.
You may also choose to use petty cash vouchers. The stack of vouchers plays the role of a log. Anyone making a disbursement from petty cash writes a voucher that includes:
- The amount disbursed
- The date
- The person getting the money
- The reason for the disbursement
- The account being charged
- A signature of the person making the disbursement.
If the amount of cash in the lockbox ever doesn’t match the amount recorded in the balance column, that means someone made an error recording information into the log, or that some of the petty cash has gone missing.
Further reading: The Art of Bank Reconciliation
Step 6: Start using your petty cash fund
Let’s say your office runs out of pens, and you need to buy some from Staples.
To use petty cash, simply grab however much cash you need from the lockbox (say, $10). When you return from Staples, deposit the receipt for the pens along with any remaining change (let’s say it’s $3.67 in this case) back into the lockbox, and make a corresponding entry in the petty cash log.
Step 7: Get used to replenishing your petty cash fund
Let’s say that at the end of the month, you have $49.15 remaining in your cash box, and you want to top your petty cash fund by $150.85 to get it back up to $200.
To do that, you’d simply write another check to petty cash, this time for $150.85, cash it, deposit the cash in the lockbox, and make the appropriate entry in your petty cash log.
Step 8: Record the top-up in your accounting system
The first step to recording a petty cash top-up in your bookkeeping system is to summarize all of the small expenses that were paid for using petty cash. We might summarize the expenses from the petty cash log above in the following way:
Now that you’ve got all your petty cash expenses summarized, make the following journal entry in your accounting system:
Once you’ve entered your petty cash transactions on the books, your bookkeeping can use them while creating financial statements—so you can accurately factor petty cash into your expenses.
If you use accrual accounting, the top-up may be credited from accounts payable instead of cash.
Some tips on how to run a petty cash fund effectively
Put your petty cash policy in writing
Make sure everyone with access to petty cash funds knows what they’re for, and provide some examples of typical petty cash expenses to make sure there’s no confusion.
Make sure everyone uses the petty cash log
It might seem tedious to log every tiny expense in this way, but there’s nothing petty about petty cash expenses. You must document all of your petty cash expenses if you want to write them off on your taxes, just like you would any other income or expense.
Remember to reconcile
Every once in a while, compare the petty cash balance recorded in your petty cash log with the actual remaining amount of cash in your lockbox. If the numbers don’t match, that means something went wrong, and you need to review each expense for any discrepancies.