What Is Petty Cash and How Does It Work?
Learn to effectively manage small, immediate business expenses with petty cash, ensuring financial accuracy and control.
Petty cash is a foundational element in business financial management, designed to handle minor, immediate expenditures. It allows companies to manage small, day-to-day purchases efficiently without the administrative burden of traditional payment methods like checks or electronic transfers. This system provides a convenient way to access funds for incidental costs.
What is Petty Cash
Petty cash refers to a small amount of money a business keeps on hand to cover minor, everyday expenses that are impractical to pay through formal accounting processes. This cash is intended for convenience, allowing for quick transactions like purchasing office supplies, postage stamps, or reimbursing employees for small, work-related costs such as taxi fares or coffee for a client meeting.
The primary advantage of using petty cash is its speed and simplicity. It avoids the time-consuming process of writing and approving checks for small sums, reducing administrative overhead and potential bank fees associated with numerous small transactions. While credit cards and electronic payments are common, petty cash remains relevant for situations where these methods are not accepted, or for very small purchases where their use would be inefficient.
Setting Up a Petty Cash Fund
Establishing a petty cash fund begins with determining an appropriate initial amount, which should be sufficient to cover minor expenses for a reasonable period, such as a month. Businesses often set this amount based on anticipated frequency and size of small disbursements. Once the amount is decided, a dedicated petty cash custodian is appointed to manage the fund. This individual is responsible for overseeing disbursements, maintaining records, and ensuring the fund’s security.
The physical cash is then set aside, often secured in a locked drawer or a small cash box to prevent theft or misuse. Clear policies and procedures are also established at this stage. These guidelines specify permissible spending limits per transaction and outline the types of expenses allowed.
Operating and Replenishing the Fund
The daily operation of a petty cash fund involves careful management of disbursements and adherence to documentation requirements. When cash is disbursed for an approved expense, a petty cash voucher or receipt must be obtained for every transaction. This documentation typically details the date, amount, purpose of the expenditure, and the signature of the recipient, ensuring accountability for each use of funds.
Petty cash funds commonly operate under an “imprest system,” meaning the fund is maintained at a fixed amount. Under this system, the sum of the cash on hand and the total value of all petty cash vouchers or receipts should always equal the original fixed amount of the fund. When the cash balance runs low, or at the end of an accounting period, the fund is replenished. The custodian compiles all receipts and requests a reimbursement check from the main company cash account for the exact amount spent. This check restores the petty cash fund to its original balance.
When replenishing, the main Cash account is used, and the Petty Cash account in the general ledger remains unchanged unless the overall fund amount is permanently increased or decreased. If a discrepancy occurs, the difference is recorded to reconcile the fund.
Ensuring Petty Cash Control
Maintaining internal controls over petty cash safeguards funds and ensures accurate financial reporting. A fundamental control is the segregation of duties, which dictates that the individual responsible for disbursing petty cash should not also be the one authorizing its replenishment or reconciling the fund. This separation minimizes the risk of errors, misuse, or fraudulent activities.
Regular and sometimes unannounced cash counts are performed to verify that the physical cash, combined with the total of all receipts, matches the established fund balance. A detailed petty cash log or journal should be maintained for every transaction, documenting the date, amount, purpose, and recipient. This log provides a clear audit trail and helps in reconciling the fund. Clear spending policies, including specific limits per transaction and authorized types of expenses, must be communicated and strictly enforced.
The petty cash fund is classified as a current asset on a company’s balance sheet, reflecting its liquid nature and immediate availability. Periodic reviews of the fund’s usage and adherence to established policies further strengthen control and accountability.