Cash vs Accrual Accounting Explained: What’s Better For Your Small Business
In small business bookkeeping, there are only two primary accounting methods you’ll need to know–cash basis accounting and accrual basis accounting.
Even if you trust a team like ours for your financial reporting, it’s good to understand the fundamental practice and difference between cash and accrual accounting and why one may be better for your small business.
The Difference Between Cash and Accrual
If your sales are less than $25 Million a year, you are free to use cash or accrual accounting methods. Here is a simple explanation of each, including the pros and cons so that you can always make an informed decision when it comes to your small business bookkeeping.
The difference between cash and accrual accounting is the timing of when credits and debits are recorded into your financial accounts. The Cash accounting method records revenue and expenses only when money changes hands.
The accrual accounting method recognizes revenue when it’s earned and expenses when they’re billed–not when paid. Here’s a breakdown of each.
Cash Basis Accounting
Cash basis accounting is usually considered the simpler of the two. With this method, you record expenses as their paid and income as it’s received. For example, if you bill a client for $2,000 on January 1st and receive the payment on February 1st–you would record the income as received in February. Waiting until you had the money in-hand.
Likewise, when an expense is paid, using cash accounting the expense would be recorded once it leaves the account or money is exchanged. If you were invoiced in March but paid in April, the expense would be recorded in April.
This method is not applicable to accounts receivable or payable. Whether in the form of cash, checks, or credit card receipts–cash accounting is used when payment is received.
Many small businesses prefer to use cash accounting because of its simplicity. It’s easy to track exactly when a transaction occurred and helps determine with a great deal of accuracy, how much cash the business has at any given moment. However, it can provide an inaccurate financial picture.
Accrual accounting for financial reporting follows the guidelines and standards outlined by the Generally Accepted Accounting Principles (GAAP). And provides the clearest picture of a small business’s overall finances.
When practicing the accrual accounting for small business’s method, expenses and income are recorded when they are billed and earned–regardless of when the money is actually paid or received, like in cash accounting.
For example, if $3,000 income was billed on September 1st is would be recorded as income in September’s small business bookkeeping records. Similarly for expenses. If you purchase supplies on a business credit card in September, even if you don’t pay the credit card until October, this expense is listed under September.
Accrual accounting is more complex than cash, resource-intensive, and can offer an inaccurate short-term view of your business’s financial standing.
Simplify Your Bookkeeping
We understanding that you’re passionate about your business and might not be passionate about accounting. And to prepare financial statements using these methods requires a certain level of commitment to understanding all the ins and outs. But fear not–it’s kind of our thing.
We provide detailed reports on everything from losses and profits to management and employees so that our clients are always aware of everything that’s going on. These reports can be provided at any time by request of the client.