Whether you’re doing your own accounting or placing it in the hands of a professional, knowing the differences between accrual accounting and cash basis accounting is key for keeping the books in a way that benefits your business.
What is accrual accounting?
Accrual accounting registers transactions as they occur rather than when payment is received or rendered, according to NerdWallet contributor Billie Anne Grigg. If you work with customers who tend to settle bills after a time, you would count a transaction in June as revenue even if you don’t expect to receive payment until early July. Similarly, if you make a purchase in June but don’t pay it back until the following month, the accrual method would count it toward your books in June.
What is the cash basis method?
Cash basis accounting, Grigg notes, functions in the opposite manner as accrual accounting. Known as bank balance accounting, this method only sees transactions added to your books when the payment has cleared. According to Grigg, this only applies to expenses that impact cash flow and wouldn’t apply to non-cash expenses like depreciation.
Pros and cons of accrual accounting
The QuickBooks blog points out accrual accounting is the more popular option of the two and is the best choice for providing an accurate picture of your business’ operations and stability. Because this method lets you see the month in which transactions take place, it can be better for crafting a strategy based on consumer and seasonal trends. On the flip side, this also means it’s less effective at showing accurate cash flow in the short term.
What’s more, QuickBooks’ blog notes accrual accounting is a widely used standard because it adheres to generally accepted accounting principles, or GAAP. This means any company making more than $25 million in annual sales must use accrual accounting. While your business may not be near that level right now, going with the accrual method now can prevent a sudden change in the way you keep your books when you do meet that threshold. Per GAAP guidelines, you will also need to use accrual accounting if your company is publicly traded or you plan to take it public.
One reason why businesses might avoid the accrual method is that it tends to be a bit more complex. Tracking revenue and cash flow separately can create a logistical headache if you’re doing your business accounting, but is likely more manageable if you’ve hired a professional or have accounting employees on staff.
Pros and cons of cash basis accounting
Cash basis accounting is a bit simpler than accrual accounting, because you’ll be tracking money as it moves in and out of your account. QuickBooks notes this eliminates the need to record accounts receivable and payable, which cuts down on paperwork and streamlines your processes. However, not having records of accounts receivable or payable will make it harder to figure out who owes you money if there’s a delinquent payment.
QuickBooks also notes if you go with cash basis accounting, it can help with income taxes. You aren’t required to pay taxes on money you’ve not yet received, and that extra cushion can be helpful if your business is going through a lean period and has less cash to go around.
The differences between accrual and cash basis accounting are clear, but the choice of which is right for your business falls to you. You can use accounting software or seek the help of a professional to determine which method works best and get tips for covering all your bases.