What is Petty Cash in Accounting?
Petty Cash Meaning
Petty cash is a small amount of money that is set aside by a company for day-to-day business-related purchases.
Petty cash is usually used for items bought from nearby shops that typically aren’t very expensive.
Businesses hold petty cash to enable staff to purchase small items that do not need to go through a purchase order system or expenses claim.
Usually, the items bought need to be purchased and used immediately, rather than placing an order with a supplier and waiting for delivery.
The amount of petty cash held is at the business’ discretion, but usually ranges from around £20 to £300.
In some exceptional cases, the maximum petty cash value can be much higher.
Examples of Petty Cash Purchases
Some examples of the items that petty cash is often used to purchase would include:
- Small stationary items (ie pens, paper, staplers etc)
- Postage stamps
- Birthday cards, birthday cake or small gifts
- Travel fares
- Tea/coffee/milk for the office kitchen
- Food for catering in staff or client meetings
Setting Up a Petty Cash Fund
Setting up a petty cash system involves a few important steps:
Determine the Initial Amount
There is no defined amount to deciding what size the petty cash fund should be.
Naturally, if the business expects to regular make purchases out of petty cash, the initial fund should be larger than if they expect to make fewer purchases.
Choose a Custodian
The business would then need to appoint a trustworthy employee as the petty cash custodian.
This person will be responsible for the overall management of the petty cash fund, which includes making payments and maintaining accurate records of the cash flows in and out of the fund.
Create a Petty Cash Log
The final step would be to establish a petty cash log, to record every transaction involving the petty cash fund.
Typically, the log would include the transaction date, description of the expense, amount spent/received, petty cash balance and the signature of the individual receiving the funds.
The petty cash balance on the log should also be regularly reconciled with the actual petty cash fund.
This would involve counting all of the cash in the fund, and comparing it to the balance total on the log.
How To Manage Petty Cash
As petty cash is money owned by the business, it needs to be managed effectively.
Numerous problems can arise when dealing with petty cash if a robust system isn’t in place.
Common problems include:
Perceived Importance
Sometimes the actually terminology can create a problem.
The definition of ‘petty’ is that it is of low importance, and therefore employees will often reflect this in how they treat the fund.
Their view might be that “I’m only taking out £1, it’s not a big deal”, but this attitude can make petty cash open to errors and fraud.
A lack of scrutiny towards the petty cash fund can often mean that fraudulent activities can remain undiscovered for a long time, and even the smallest of losses can add up to a significant number over an extended timeframe.
Dependance on Custodians
The responsibility to effectively manage the petty cash fund falls solely on the custodian.
More often than not, the management and focus of the fund will deteriorate over time as this person could have more pressing issues in their day-to-day work.
Independent checks and reconciliations of the petty cash fund should be performed frequently to counter this risk.
The physical location of the petty cash fund would usually be locked away in a secure safe, or a lockable drawer to prevent theft or unauthorized access.
Paper Based Approach
Managing the petty cash fund is a very manual process, which typically involves tracking all of the transactions on a paper log or Excel spreadsheet.
What often happens is that users of petty cash will leave handwritten notes for cash taken out of the fund and forget to ask for receipts.
This creates a messy process and makes tracking the costs very difficult.
These problems are then only noticed when internal audits and reconciliations are carried out.
Accounting for Petty Cash
Let’s now run through how to account for petty cash using an example from the initial setup of the fund, through to purchasing items using petty cash, and finally replenishing the fund.
Initially, a business sets up a petty cash fund with £200 to start with, taken from the business’s main cash/bank account:
Account | Debit | Credit |
Petty Cash | £200 |
|
Cash |
| £200 |
A member of staff buys a pack of envelopes and some postage stamps to send an urgent letter:
Account | Debit | Credit |
Petty Cash |
| £5 |
Office Expenses | £5 |
|
Over time, more transactions occur and the petty cash balance is reduced to £20, which is the designated amount where the custodian will top the petty cash fund back up to £200.
Account | Debit | Credit |
Petty Cash | £180 |
|
Cash |
| £180 |
Is Petty Cash an Asset or a Liability?
Petty cash is an asset, and is held on a business’s balance sheet.
Petty cash can usually be categorised as a current asset, since it expected to be used up within one year or one operating cycle, whichever is longer.
Advantages of Petty Cash
There are several advantages to using petty cash:
Efficient Process
Petty cash allows for the quick and efficient handling of small, routine expenses without the need for complex approval processes.
This can save time for both employees and the finance department and allows staff to make small, authorised purchases without seeking out approval beforehand.
Convenient
Petty cash reduces the need for staff to pay for purchases out of pocket, then claim the amount back through company expenses.
This is especially useful for businesses dealing with numerous small transactions.
Reduced Administrative Burden
Using petty cash for small expenses reduces the need for extensive paperwork that would typically be associated with processing individual transactions.
Disadvantages of Petty Cash
While using petty cash can bring several benefits, we should also be aware of the disadvantages it can bring:
Risk of Misuse
One of the main disadvantages is the risk of misuse or theft of petty cash.
If proper controls are not followed, there is the potential for unauthorised expenditures or purchases that are not business related.
Lack of Accountability
If not properly managed, petty cash transactions may lack transparency and accountability.
If a clear record keeping system is not followed, such as unambiguous descriptions of spend and keeping receipts, it can be challenging to trace how funds have been used.
Security Concerns
Physical cash is vulnerable to loss or theft.
Keeping cash on hand in the office poses security risks, and businesses must take precautions to safeguard the petty cash fund.
The most common method is to use a petty cash tin that has a lock and key.