Cash Basis Accounting vs. Accrual Accounting

Cash basis accounting and accrual accounting are different methods of accounting which are used to record transactions. The difference between the two is found in the timing of when sales are made and when these sales are recorded. Both types of accounting affect businesses differently. Let’s take a look at the difference between these two fundamental forms of accounting.

Cash Basis Accounting

Cash basis accounting recognizes revenue which has been made and expenses which have been paid the moment cash is exchanged. Cash basis accounting does not take accounts payable or accounts receivable into consideration.

Cash basis accounting is used most commonly in small businesses as it is much less complicated than accrual basis accounting. It is also much easier to trace transactions with this process and is an easy way for a business to understand how much cash they have at any given moment. The revenue is reported on statements when the cash has been received, and expenses are recorded when they are paid.

Accrual Basis Accounting

Accrual basis accounting takes revenue and expenses when earned instead of when money is paid or received. It is more commonly used than the cash basis method.

Accrual basis accounting provides businesses with a realistic picture of both expenses and income during a specific time period and also gives these businesses a long-term idea of the cash they will have at their disposal at any given time.

In accrual basis accounting, money is accounted for when it is actually earned. This means that the revenue is recorded before money is exchanged. Despite the fact that cash has not yet been paid out, the expenses are still recorded with the expectation that they will eventually be paid out.

For example, if a business sells a piece of equipment for $500, a business using the cash method would not record the amount until the money is received from the customer. In the accrual method, the transaction is recorded immediately, even if the money will not be paid out until later. The same goes for expenses.

Advantages And Disadvantages of Both Methods

There are different advantages and disadvantages related to both accounting methods. The type of method a business uses depends on its goals, size, and type of business.

Cash Basis Accounting

The cash basis method is simple and easy to track. That being said, one disadvantage is that it may not show a realistic picture of a business’s profitability. A business may be cash rich but may also have large amounts of accounts payable that are not recorded in the books. This can make it seem like the company is making a much larger profit when in actuality the business may actually losing money.

Accrual Basis Accounting

This method offers a more accurate picture of how profitable a company is, notably in the long term. One disadvantage is that because this method does not depict any cash flow, any major cash shortage in the short term may not be accounted for. This method also tends to be a much more complicated process because a business has to account for prepaid expenses and unearned revenue.

The Right Method for Your Business

Accrual basis accounting is the most common form of accounting that businesses use because it can even out earnings over time. The accrual method gives a business a better picture of its income, expenses, and profitability, while the cash method gives a company a better idea of its cash flow.

When choosing an accounting method for a business, you may want to speak to a CPA. The method you choose for your business will depend on its size and revenue, as larger companies and corporations are legally required to use the accrual basis method while smaller companies have the option of deciding between the two.