Cash vs. Accrual: Do you know which accounting method is right for your business?

© Can Stock Photo Inc. / vinnstock

There are two methods for keeping track of your business income and expenses, and all small businesses must make a choice between the two: cash or accrual. Knowing the difference between the two determines how your business records income and expenses.

Cash Basis Accounting

A small number of businesses operate with the cash method. Generally, when using the cash method, income is recorded when the payment is received from the customer. And in the same way expenses are recorded when they are actually paid for via check or cash. Cash basis businesses can almost produce an income statement from their checkbook, as it has a record of revenue, total deposits from customer payments and expenses and checks written. This is accounting in its simplest form. EXAMPLE: A consulting firm completes an assignment in November but doesn’t get paid until three months later. Under the cash method, they cannot record the income until payment is received in January.
The cash method does not take into account the credit you’ve extended to customers or credit used to purchase supplies, which can skew your income and expense numbers.

Accrual Basis Accounting

Most businesses operate on the accrual basis. By using the accrual method, revenue is recognized when it is earned even if you have not received payment. In other words, if you invoice a client today, you will record the revenue on the date of the invoice, not when the client pays the invoice. As with expenses you will record the expense the day it is incurred although it is not paid until a later date. EXAMPLE: A computer repair business completes a job in November but doesn’t get paid until January. Under the accrual method, they would record the income on their November books.

Most experts believe the accrual method gives you a more accurate financial picture, because it accounts for all inflows and outflows of your business. By tracking accounts receivable and accounts payable, you will have a better picture of your finances for any given period.

Accrual method accounting not only affects the profit and loss statement but the balance sheet as well. It is recommended that you weigh the pros and cons of both, and decide which is best for your business and seek the advice of your CPA.