Cash vs. Accrual Accounting

What does it mean and why does it matter?

This question never stops coming. I have been an accountant, auditor, and consultant for almost 10 years and every year, there are multiple small businesses asking: What’s the difference?

Cash vs. Accrual Accounting

Let’s dive straight into it: 

Cash Method: expenses and income are recorded when cash is received. 
Accrual Method: expenses and income are recorded when they are earned or incurred.

Do you see the difference? 

If you are still unclear, think about it this way:

For example, you receive a bill for electricity today 4/27/2020 for this month’s consumption and pay it on 5/10/2020. 

  • Cash:  When you pay the bill on 5/10/2020; this is the date the expense is recorded. 
  • Accrual: You receive the bill on 4/27/2020; this is the date the expense is recorded as the expense has been incurred

What does it mean incurred

Incurred means that something happened or occurred, thus the Accrual method says: If it occurred, then it needs to be recorded. The Cash method says: It will be recorded when paid, when cash goes out. 

Why does the accounting method matter?

With accrual you get a more realistic picture of whether your business is financially healthy. Many times, as a business you provide services or sell products that are not paid on the spot. Thus, the accrual method recognizes them as income. If the services were performed or the product was sold, it should be recorded as income. 

The Cash method does not recognize a product or service sold until cash has been received. 

The same goes for expenses. Many times, we receive invoices or bills for expenses that are not due for a while. Thus, with the accrual method, we record them when we receive them. The cash method records them when the bill or invoice is actually paid (cash goes out). 

In my opinion, the accrual method helps small businesses more as everything is recorded in the books and there are no lingering transactions. A business at any time knows the income/sales and expenses. If a business needs to apply for a loan and there is a high volume of sales, where cash has not been received, it will help them. Also, throughout the year, it helps small business owners strategize and determine the tax impact at year-end.  

Which accounting method is right?

Overall, there is not a right or wrong accounting method. It is a matter or preference and which one makes more sense for the business based on business type, size, complexity etc. 

At Dynamic Risk Consulting LLC, we strongly encourage our business patterns to use accrual as it provides the full picture allowing business owners to strategize and make better business decisions. However, many small businesses prefer to use the cash method.  

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See more about Cash vs. Accrual Accounting here.

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