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What Is the Difference Between Cash and Accrual Accounting?

by Marie Bernier

August 13, 2015

Cash and Accrual Accounting

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.

A Common Example

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.

Pros and Cons of Each

Let’s start by looking at the pros and cons of the cash accounting method:

  • Less Bookkeeping (Pro): Overall, tracking your expenses will be relatively straightforward and simplified with this form of accounting.
  • Inaccurate Representations of Long-Term Revenue (Con): While this accounting method can track cash flow accurately, it often provides inaccurate information regarding your long-term revenue. This occurs because you could have made a sale in one fiscal year or calendar month, but you don’t receive payment until a later date, which is when the income is recorded on your financial statements.

Now, let’s consider the pros and cons of the accrual method of accounting:

  • Accurate Representations of Long-Term Revenue and Expenses (Pro): This form of accounting gives you a more accurate long-term picture of your revenue and expenses.
  • More Bookkeeping (Con): Overall, accrual bookkeeping requires more work, since you’ll need to keep tabs on more than just what you’ve been paid (or what you’re paying). In addition, a business runs the risk of overspending if you do not closely track your aged receivables and follow a disciplined collection process. For this reason, many companies use an accounting tool or software for accrual bookkeeping.

As you can clearly see, neither form of accounting is perfect.

Which Accounting Method Works Best?

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.


Sources:

  1. Cash accounting or accrual accounting? Which one is right for you?
  2. What is the difference between the cash basis and the accrual basis of accounting?
  3. How does accrual accounting differ from cash basis accounting?

 

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