Final answer:
Setting up a petty cash account involves creating a small cash fund for minor business expenses, improving cash flow management. As the petty cash is used, receipts are collected, and when low, it is replenished from the business's bank account, keeping track of cash and avoiding overdraft fees.
Step-by-step explanation:
When you set up a petty cash account, you are creating a small fund within your business to cover minor expenses. This fund is used to improve cash flow management and ensure that small, incidental purchases can be made without the need to write checks or use a credit card. Initially, a certain amount of cash is taken out of the business’s bank account and placed into the petty cash fund. As expenditures are made from this fund, receipts are collected to account for the disbursements. When the petty cash fund runs low, it is “replenished” back to its original amount by withdrawing the total of the expenses in cash from the company’s bank account, ensuring there’s always a set amount of cash on hand for these small purchases.
Moreover, managing a petty cash fund is an essential part of balancing your checkbook, as it helps keep track of cash on hand and prevents potential overdrafts and the fees associated with having insufficient funds in your main bank account. For businesses, especially small businesses, maintaining a petty cash system is an alternative to the full banking system, which simplifies transactions for minor daily expenses, such as office supplies, business errands, or employee reimbursements. This method provides convenience and speeds up the transaction process compared to the typical bank withdrawal methods like writing a check or using a debit card.