What Is the Difference Between Accrual Accounting and Cash-Based Accounting?

When you first started your business, you probably didn’t even realize how many different kinds of accounting you have to choose from. Most people assume it’s a straightforward matter of keeping track of the money coming in, the money you spend, and making sure your income always exceeds your expenses.

But let’s say you send a client an invoice and it takes a few weeks (maybe even months) before they pay their bill. Do you record that income as soon as you send the bill? Or do you wait until you get the money?

That’s the difference between accrual accounting vs cash-based accounting. Each option has its own advantages and disadvantages, so before you decide which option is best for your small business, let’s go over the pros and cons of each one.

What Is Accrual Accounting?
Accrual accounting is an accounting system in which you track income and expenses before any money has changed hands. That means you count income as soon as you create an invoice for that income, even if your client has yet to pay.
When it comes to expenses, you might mark a bill as having been paid when you receive the bill, rather than when you pay it. If you have monthly expenses, you might account for each expense on the first of each month, even if you don’t pay those bills until later in the month.

What Is the Benefit of Accrual Accounting?
The main benefit of accrual accounting is that it gives you an opportunity to plan ahead by giving you an idea of how much money you have coming in vs how much is going out in the near future. You can use this information to determine whether it’s time to invest in new resources for your business or if you’re better off keeping your expenses where they are for the moment (or even lowering them) until you can expect to have more money coming in.

What Is the Drawback of Accrual Accounting?
When you use accrual accounting, you pay taxes on the income your bookkeeping system has accounted for, even if you have not yet received the cash. Depending on the solvency of your business and how much money you are waiting on, you might have a hard time paying those taxes before the invoices are paid.
Hopefully, you never have to worry about bills that never get paid, but it is a risk that every business runs when it provides products or services before getting paid in full. If you use cash-based accounting, you don’t have to worry about reporting that income, but with accrual accounting, you’ll end up paying taxes on that income, even if it never ends up in your bank account.

What Is Cash-Based Accounting?
In cash-based accounting, you don’t record any income or expenses until after money has either landed in or exited your bank account.

What Is the Benefit of Cash-Based Accounting?
Cash-based accounting is best for tracking a company’s cash flow because it gives you a clear idea of how much money you have in your bank account right now. For this reason, cash-based accounting is most often used by private companies, and by distressed companies with a cash shortage so they can share the information internally with their investors, or with the Bankruptcy Court if necessary.

What Is the Drawback of Cash-Based Accounting?
While cash-based accounting is great for keeping track of your company’s cash flow, it’s not as good at helping you figure out how much money you can expect to have in next month, three months from now, or even three years from now. You’ll either need to switch to accrual accounting, or use another system in addition to your accounting system to make projections about the future of your company’s cash flow.
Whether you’ve chosen an accounting system and you just need a bookkeeper to implement it for you, or you’re still deciding which accounting system to use, I can help. After all, you went into business to make money. Why not hire someone to help you take good care of that money? Reach out now to get your FREE consultation.