Cash Vs Accrual Accounting

You've probably heard of cash versus accrual accounting, but what does it all mean? We go over the fundamentals.

The distinction between cash and accrual accounting

The distinction between cash basis and accrual basis accounting is based on timing. When do you report revenue and when do you record expenses? Cash basis accounting is used when money is paid or received. It is accrual basis accounting if you do it when you receive a bill or raise an invoice.

Although accrual accounting is a significantly more powerful instrument for business management, cash accounting has its purposes.

What exactly is cash basis accounting?

Cash-basis businesses recognise income and expenses only when money changes hands. They do not consider submitted invoices to be income or bills to be expenses until they have been settled.

Contrary to popular belief, cash basis accounting has nothing to do with the type of payment you get. You can be paid electronically while maintaining cash accounting.

The Advantages of Cash Accounting

It's straightforward and shows how much money you have on hand.
You only have to pay tax on money received rather than invoices submitted, which can help with cash flow (but not all businesses are allowed to use cash basis accounting for tax so check with your tax office)

Cash accounting disadvantages

It is inaccurate; it may portray you as profitable simply because you haven't paid your bills.

It is ineffective when making management decisions because you just have a day-to-day perspective of finances.

What exactly is accrual accounting?

Businesses that employ accrual accounting record income as soon as a customer invoice is raised. When a bill arrives, it is recorded as an expense even though payment is not due for another 30 days.

The Advantages of Accrual Accounting

You get a much clearer picture of the company's operations and finances.

You can make significantly more confident financial decisions.

It can be easier to pitch for long-term financing at times.

The disadvantages of accrual accounting

It requires extra effort because you must monitor invoices in addition to your bank account.

You may have to pay tax on income before the client has paid you - if the customer does not pay you, you can claim the tax back on your next return.

Accounting approaches that are hybrid

A hybrid accounting system is used by some firms. They may base major financial decisions and loan applications on accrual accounting, but they employ cash-basis accounting to ease some aspects of their taxation. There are many restrictions on who can and cannot do this. Find out what applies to you by speaking with an accountant or tax specialist.

Cash accounting vs. accrual accounting vs. hybrid accounting

Accrual accounting provides a more accurate picture of corporate performance since it reveals when income and expenses occur. If you want to see if a certain month was lucrative, use accrual. Cash basis accounting is also used by some businesses for tax purposes and to maintain track of their cash flow. However, cash accounting is rarely used on its own.

While accrual accounting requires more labour, technology may do the majority of the heavy lifting for you. Accounting software can be set up to read your bills and enter the amounts directly into your expenses on an accrual basis. As you raise invoices, it will also record them as income. Furthermore, if you use a hybrid accounting system, intelligent software will allow you to move between cash basis and accrual basis as needed.

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