Cash Basis Accounting vs Accrual Basis Accounting
What’s the difference between cash vs accrual accounting? A lot comes down to timing. With cash, the recognition of expenses and revenue is almost instant. With accrual, expense and revenue are accounted for later. Take a look at your business’s accounting system–are you accrual or cash basis?
What Is Cash Basis Accounting?
Cash basis accounting is for businesses operating with a direct exchange of money. Nothing is settled until cash is in hand. Bills are not expenses. Invoices are not income. Accounts are reconciled when the money is there.
With cash basis accounting, your business doesn’t have to receive literal cash. Businesses who use the cash basis method–typically sole proprietors and non-inventory based operations–can be paid electronically or otherwise.
One of the benefits of cash vs accrual accounting is that it’s relatively uncomplicated. Plus, it’s less expensive to do cash vs accrual accounting because no accountants are needed. What cash you have on hand is the money your business has to spend. When it comes time for taxes, your business only has to pay on the money it has received.
A drawback to cash basis vs accrual basis is that it paints an inaccurate picture of your finances. Your business could be showing a profit just because it hasn’t paid its bills. This might make it harder to get the full scope of where your business stands. Decisions could be trickier or inaccurately based.
What Is Accrual Basis Accounting?
Accrual basis accounting is a method of accounting where financial transactions are recorded when they are incurred, regardless of when the cash is received or paid. Under accrual basis accounting, revenues are recognized when they are earned, and expenses are recognized when they are incurred, regardless of whether the cash has been received or paid.
Accrual accounting vs cash accounting means a business identifies income on the books when an invoice is generated. With bills, they are categorized as expenses, even if payment is a month away.
One of the upsides to accrual v cash basis accounting is that your business always knows where it stands with money. Whether it’s making directive decisions or asking for long-term financing, accrual accounting can back up the business with solid numbers.
However, the flip side is that accrual accounting takes much more work to keep up the books. Invoices must be kept track of along with your bank account. On top of that, your business owes taxes on invoices, even if payment has not been collected. Businesses with an average annual gross of sales topping $25 million are required to do accrual accounting for the 3 previous tax years.
Cash Basis vs. Accrual Basis: What’s The difference?
When it comes to cash vs accrual accounting, it’s almost all in the timing and amount. If you’re a small business, cash might be the easiest accounting method. For a bigger business, chances are you’ll need to go the accrual route.
Here are some key differences to keep in mind for cash vs accrual accounting:
| Cash Basis | Accrual Basis | |
| Timing Of Transactions | Logged when cash is received or spent. | Logged when a sale or expense is on the books. |
| Money Taxed | For only received income. | For all recorded income. |
| Business Size Requirements | None | All businesses with $25 million in revenue annually. |
How To Choose The Right Option For Your Business:
The best way to decide between accrual vs cash accounting for your business is to take a look at the size of it, as well as how it functions.
Do you have inventory? If so, accrual vs cash basis is probably your best option.
Does your business make thousands of dollars each year, but not millions? Maybe consider operating with a cash vs accrual accounting method. Are your sales in person or online? You might have to carefully decide between the cash or accrual method.
Both cash vs accrual accounting advantages and disadvantages. If you can’t decide between cash vs accrual, look into a hybrid option. You might simplify your tax process with cash basis accounting while securing long-term financing with accrual. Plenty of laws and rules are in place for this model. If you can’t decide between cash basis vs accrual basis accounting, consult an accountant. There might be a way to have your small business do both.
The Effects Of Cash And Accrual Accounting:
There are plenty of reasons to pick the cash or accrual method for your business. Whatever you end up choosing, make sure to research the strings attached. There are taxes, policies, and lots of rules when using cash or accrual accounting.
For cash, design a system to keep up-to-date on customer accounts. You might have outstanding invoices. Your business won’t have accounts receivable ledgers. Watch what money comes in and goes out carefully.
If your small business is dealing primarily in cash, keep your records and money safe. Ensure the protection of all receipts and disbursement records to prevent theft or loss.
With accrual, create a process to reconcile your accounts at the bank. Track all short-term cash flow transactions, too. You might not see the money in hand, but the IRS will.
Entrepreneurs and startups need to check in with their accounting policies as they expand. A small business using the cash accounting method for ease might grow out of it. They need to keep the policies around accounting up-to-date. If your business has investments, assets, and public offerings, it’s time to change from cash to accrual.
Conclusion
Review your company’s operating blueprint before deciding on cash vs accrual accounting. If you need more info to distinguish between cash basis and accrual basis of accounting with examples, look at similar businesses to see how they track their money.
