Cash and accrual basis accounting are distinct bookkeeping methodologies. Their core difference is in the timing of when revenues and expenses are recorded in your books.
Cash basis records transactions when money is exchanged; while accrual basis records transactions as soon as an invoice has been sent or a bill has been received.
While the concept is simple, transaction timestamps can have a handful of effects:
|Simple. Easy for small businesses that rely only on cash transactions.||Timing differences between when you recognize revenue and expenses can make it difficult to tell your profitability at a specific period of time.|
|More accurately shows cash flow.||Not accepted under GAAP and IFRS.|
|Shows how much money your business currently has in the bank account.||Can’t be used for tax purposes if your gross receipts exceed $5M or if you keep an inventory of merchandise.|
|Recording transactions are simpler, so complex accounting systems aren’t usually needed.||Doesn’t give a good indicator of long-term profitability. Can’t show profitability if money is tied up in orders.|
|You only pay taxes on the money in your account.||Your receivables or payables are not clear just from accounting records.|
|You can accurately measure profitability during a specific time period.||Cash flow needs to be calculated separately.|
|Accepted under GAAP and IFRS||You could pay taxes on money you haven’t actually received.|
|It’s easier for investors to see how the company is performing before any money is actually taken in.||More complicated and difficult to manage than cash basis accounting.|
Typically, cash basis accounting is best suited for small businesses with lots of transactions. It’s straight-forward and is often easier than accrual accounting.
There’s tax benefits too. With cash basis accounting, you pay taxes on money that was actually received. You don’t pay taxes on uncollected receivables.
You will have to be more careful about measuring profitability because you won’t clearly see accounts payable and accounts receivable - you might think you’re bringing in a higher cash-flow than you actually are.
Accrual basis accounting is usually best for larger businesses that don’t get paid quickly.
Accrual accounting is required by the IRS under certain circumstances including earning over $5M in sales in the year or if you need to keep an inventory of merchandise.
Some businesses choose to use a cash-accrual hybrid form of accounting to keep track of current finances as well as long-term finances.
Typically cash vs. accrual basis is a simple setting in your accounting software. Most systems have the ability to track receivables and payables.
It is important to choose accounting software that has the right capabilities for your business. Whether you need assistance with accrual accounting, cash accounting, or both, make sure your software of choice can handle it.