The difference between cash and accrual accounting is important to understand, whether you handle your own financial statements, or hire an outside professional. The difference lies in the timing of when sales and purchases are recorded in your accounts.
Under the cash basis of accounting:
- Revenues are reported on the income statement in the period in which the cash is received from customers.
- Expenses are reported on the income statement when the cash is paid out.
Many small businesses opt to use the cash basis of accounting because it is simple to maintain. It’s easy to determine when the transaction has occurred (the money is in the bank or out of the bank) and there is no need to track receivables or payables. The cash method is also beneficial in terms of tracking how much cash the business actually has at any given point in time; you can look at your bank balance and understand the exact resources at your disposal. Also, since transactions aren’t recorded until the cash is received or paid, the income isn’t taxed until it’s in the bank.
Under the accrual basis of accounting:
- Revenues are reported on the income statement when they are earned—which often occurs before the cash is received from the customers.
- Expenses are reported on the income statement in the period when they occur or when they expire—which is often in a period different from when the payment is made.
The accrual basis of accounting provides a better picture of a company’s profits during an accounting period. The reason is that the income statement prepared under the accrual basis will record all of the revenues actually earned during the period and all of the expenses incurred in order to earn the revenues. The accrual basis of accounting also provides a better picture of a company’s financial position at a moment or point in time. The reason is that all assets that were earned are reported and all liabilities that were incurred will be reported.
Choose the method that works for you
You can make the most of the method you choose by understanding what the numbers produced mean, and using them to answer your business’s specific financial questions. When it comes to significant accounting decisions like selecting the cash or accrual method, consulting a professional can help you feel confident that you’ve made the best choice for your business, as well as afford you valuable, strategic advice going forward.
Get in touch with BLG Business Advisers online or by calling (02) 4229 2211, to discuss your specific needs and which method would be best for you and your business.