When comparing cash accounting vs. accrual accounting, the primary difference between them is simply timing or, more specifically, “when” revenue and expenses are recorded. Small businesses and people managing their personal finances often use the cash method. This method accounts for “revenue” only when money is received, and for “expenses” only when money is paid out.
On the flip side, with the accrual method of accounting, revenue is recorded at the time of the service or sale, rather than when the money is exchanged. Though the variance between the approaches may not seem wildly different for some B2C companies, it’s common for B2B businesses to experience delays when receiving payments.
Let’s look at an example to help you become familiar with the primary differences between cash and accrual accounting. Pretend that you run a business that focuses on selling machinery. If you sell a piece worth $10,000, then under the cash based method, you would record the amount in the books after the customer has remitted payment. However, under the accrual method, you would record that $10,000 immediately following the sale, even if you didn’t receive the money until some future time.
The exact same concept works for expenses. If you receive an electric bill for $2,000, then under the cash accounting method, you would record the amount on your books after officially paying your bill. With the accrual method, you would record the $2,000 as an expense the moment you receive the bill. As you can see, the concepts themselves aren’t that complicated to understand. Now that you’re familiar with the difference between accrual and cash accounting, let’s delve into which one is better and why.
Let’s start by looking at the pros and cons of the cash accounting method:
Now, let’s consider the pros and cons of the accrual method of accounting:
As you can clearly see, neither form of accounting is perfect.
The answer to this question is largely based on they type of business, frequency of transactions and proficiency in the recording of revenue and expenses. Due to its simplicity, the cash accounting method is often utilized by Small Businesses, but all factors must be considered before selecting an accounting method for your business.
If you’re unsure about which one is right for your business, be sure to speak with a certified public accountant or tax advisor first, as they’ll be able to steer you in the right direction.
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