Samantha Speakes - 02/20/2024

Do you have a business idea or growing small business and you're now in the thick of how should I be recording my business transactions? Let's break down the difference in cash verse accrual accounting and help you find the solution that's the best fit for your business. 

Cash and accrual accounting are two different methods for recording your business transactions, with the main difference being when the transactions are recorded. Cash basis accounting only records income and expenses when payments are made and received, while accrual basis accounting records income and expenses when they are incurred, whether money has been exchanged yet or not. 

So, which method is best? The answer will depend on your business needs speficially. The short answer, accrual basis accounting is generally the best option and the most accurate picture of your business performance and health. However, the complexity of accrual accounting might outweigh the benefits for a very small basic business model. One key question to answer is if your business does (or plans to) track accounts receivable and accounts payable. As an organization we generally recommend our clients use Accrual Basis Accounting; we have highlighted the differences, advantages and disadvantages of both below. 

Cash Basis Accounting

With cash basis account, transactions are ONLY recorded when cash PHYSICALLY moves in or out of your business. In accounting terms, revenue is only recognized as income when you receive payment and expenses are only recognized when money is spent. With rare exceptions (depreciation, amortization, etc.) only transactions that have cleared your checking or credit card accounts should appear on your cash basis financials statements. 

What are the benefits with cash basis accounting?

The biggest advantage of cash basis accounting is its ease of implementation, maintenance and understanding. If you choose to maintain your books using cash basis accounting there will be little difference between your financial statements and your tax returns and your income statement will very closely mirror your cash flow. A cashflow is a great snapshot for you to look at as a business owner, having that mirror your income statement is one less report for you to review at month end. 

What are the downsides to cash basic accounting?

There are two major disadvantages of cash basis accounting; it is not GAAP compliant and it doesn't track accounts receivable or payable. GAAP refers to the Generally Accepted Accounting Principles, governed by the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC). Cash basis accounting ignores both the matching and revenue recognition principles of GAAP, these along with the other principles used in GAAP are recognized as the foundation of good accounting practices. Publicly traded companies MUST follow GAAP, and if you are a small business applying for loans you should be as well. 

Cash basis accounting also does not track accounts receivable or payable, as notes above. If your business currently does or plans to rely heavily on either or both accounts receivable or accounts payable, then cash basis accounting will not give you an accurate view of your business financial health and performance. Examples of business that rely heavily on receivables or payables are service based business with invoice terms, business that purchase goods on accounts from vendors with invoice terms, manufacturing business with bills of material for manufactured items and business who maintain inventory and employ sales invoices via accounts receivable. If your business uses cash basis, but relies on the above (or other like receivables/payables) then your financial statements might lead you to a false sense of higher profitability, when in reality you might not be breaking even once vendor bills or bad debt(receivables) are taken into account. 

Accrual Basis Accounting

With accrual basis accounting income and expenses are recognized when they are incurred, this method tracks accruals or unpaid expenses or invoices that customers have yet to pay. Income is recorded when it is earned, for example when a good purchased by a customer leaves your warehouse and is shipped to them it would be earned when it leaves your warehouse, verse when the customer eventually pays the invoice you have sent them. Expenses are are entered into accounts payable when the invoice is received from the vendor and recorded when the item is used to produce income, for example packaging used to bottle wine at a winery would remain on your balance sheet as packaging material until the wine was bottled then it is recorded up into cased goods of finished product. It would be recorded as a sale of cased goods and deplete inventory when the sales invoice was sent to the customer at time of shipment to them. 

What are the benefits to accrual basis accounting?

One advantage to accrual basis accounting is the accuracy it can provide in the picture of your business's financial health. Why? Accrual basis takes your business's unpaid expenses and customer's unpaid invoices into account, meaning it does a better job at matching (a GAAP principle) your expenses and revenue to the period they were incurred. Accrual basis accounting also enables you to have a complete view of your balance sheet, including accounts receivable, accounts payable, current and fixed assets, as well as all liabilities (short and long term). 

Accrual basis accounting is also GAAP compliant, meaning it conforms to the standards and principles of generally accepted accounting principles and will allow you to more easily scale your business successfully as it continues to grow; requiring less work from you down the road if your business gets to the point of needing to be fully GAAP compliant. GAAP compliance is also a huge bonus if you are ever in an audit situation as well. 

What are the downsides to accrual basic accounting?

Though we generally recommend accrual basis accounting to all of our clients; we also like to highlight the potential disadvantages for small businesses. Accrual basis accounting can be cumbersome and time consuming for those that aren't familiar with it or those just starting their venture into small business ownership. It can take additional effort to keep accurate accrual basis books, which is not always the right fit for very small businesses. 

An additional disadvantage is for those business who are cash basis taxpayers. If you file your business taxes on cash basis, accrual accounting can potentially obscure tax liabilities. Your CPA or tax preparer should easily be able to convert your accrual statements to cash basis for tax purposes, however if you aren't regularly looking at both your cash and accrual books you could be in for a shock at tax time. 

So, What Should Your Business Use, Cash or Accrual Accounting?

If you've read through the advantages and disadvantages above and are still unsure which method is right for your business, we are here to help!