Cash Vs Accrual Accounting Explained

Ever hear the phrase, "Don't count your eggs before they hatch?"

Well to explain cash vs accrual accounting in very simple terms, accrual accounting is counting your eggs before they hatch and cash accounting is waiting until the eggs hatch and only counting the chicks that survive.

But now let's go into a little more detail about how cash vs accrual accounting works and why you might choose one over the other.

Cash Accounting

We will start with cash accounting because it is the easiest to understand. All cash accounting looks at is cash in and cash out.

When it comes to income, cash accounting only takes into account money that has already been received. It does not take into consideration money that is owed to you.

The same goes with expenses. In cash accounting, you receive a bill, you pay it, you don't enter it and pay it later.

So if you were preparing Profit and Loss Statements for each month of the previous year, the only transactions that you would see for each month would be money that came into your business and money that went out of your business.

We would not take into account money owed to you or money that you owe for any given period. With cash-based accounting, the egg isn't counted until it's hatched into a living, chirping chick.

Why Cash Accounting?

You would choose to do your bookkeeping on a cash basis if,

1) You don't bill your clients, or if you do bill your clients they pay promptly. Then cash accounting would be the simplest, most straight-forward and most accurate for your business. This way you always know exactly how much cash you have at any given time.

2) Ask your certified public accountant how she files your taxes. Certain tax laws apply to certain business types.

Your accountant who oversees the filing of your tax return should be able to tell you whether your taxes are filed based on cash or accrual accounting.

If your taxes are filed on a cash basis, you will want to make sure that your bookkeeping reflects this.

Accrual Accounting

Accrual accounting is a little bit more complicated than cash accounting and takes a little bit more knowledge of bookkeeping terms which we will get into later.

But to explain it as simply as possible, if you use the accrual-based accounting method, your financial statements reflect money as you bill it and as it is billed to you.

In this case, if you pull up a financial statement for last January, rather than reflecting how much money you received in income and how much money you paid in expenses, your statement would reflect how much money you invoiced your clients for and how much money was billed to you by your vendors and creditors.

Why Accrual Accounting?

1) You extend credit to your customers or clients and there is a long lapse between the time you provide the product or service to them and the time they actually pay you.

2) You want to be able to write off bad debt on your tax return.

3) You have investors.

4) Once again, you should discuss with your certified public accountant who files your tax return which method is best for your business and make sure your bookkeeping reflects this.

Still Perplexed Over Cash vs Accrual Accounting?

Ultimately, you will choose the method of cash or accrual accounting based on which best reflects the financially state of your business.

If you didn't receive a lot of money last month, but you know you are owed a lot of money, you might want to look at an income statement that reflects your net income after you receive all the money owed to you. In that case, you would look at an accrual-based statement.

If you want to see the net income of how much money you received after all expenses you paid in a given month, then you will look at a cash-based statement.

Many bookkeeping programs used today have the option of cash vs accrual accounting built right into them and you can easily switch back and forth.

Still have questions? Check out the FAQ's or contact us with your questions.

Return from Cash vs Accrual Accounting to Stress-Free-Bookkeeping HomePage