Accrual accounting Vs Cash-based accounting
If you are a business owner, you may have heard of accrual accounting and cash-based accounting, but you may not be sure what the difference is between the two.
Both accrual accounting and cash-based accounting have their benefits, so it is important to understand both methods to make the best decision for your business.
Here is a breakdown of the differences between accrual accounting and cash-based accounting, as well as the benefits of each method.
What is accrual accounting and how does it work?
Accrual accounting is an accounting method that recognises revenue and expenses when they are earned or incurred, rather than when they are paid.
This means that revenues and expenses are recorded in the period in which they occur, regardless of when the money changes hands.
For example, if a company provides services to a customer but does not send an invoice until the following month, the revenue would still be recognised in the month that the services were provided.
The accrual basis of accounting provides a more accurate picture of a company’s financial position than cash-based accounting, which only recognises transactions when cash (or cash equivalent) changes hands. As a result, accrual accounting is generally preferred for financial reporting purposes.
What is cash-based accounting and how does it work?
Cash-based accounting is a system of accounting that focuses on recording transactions when cash (or cash equivalent) changes hands.
This means that revenue is only recognised when it is received, and expenses are only recognised when they are paid.
This method of accounting is favoured by small businesses because it is simple to track and doesn’t require as much upfront planning as accrual-based accounting. However, it can also lead to some discrepancies between the reported income and the actual cash flow of the business.
For this reason, businesses that use cash-based accounting must be careful to track their expenses and revenue accurately to ensure that their financial statements are accurate.
The benefits of accrual accounting
Accrual accounting is an important tool for businesses of all sizes.
By recognising revenue and expenses when they are incurred, rather than when they are paid, businesses can get a more accurate picture of their financial health. This information can then be used to make more informed decisions about spending, investment, and other financial matters.
Accrual accounting can also help businesses to better manage their cash flow, as they will have a better understanding of when revenue and expenses are likely to occur.
In addition, accrual accounting can provide valuable information for tax purposes. By tracking revenue and expenses on a monthly or quarterly basis, businesses can get a clearer picture of their tax liability and make appropriate preparations in advance.
Overall, accrual accounting provides many benefits for businesses of all sizes.
The benefits of cash based accounting
Cash-based accounting is a popular choice for small businesses and startups due to its simplicity and ease of use.
Since it focuses on recording transactions when cash changes hands, it is much easier to track than accrual accounting, which recognises revenue and expenses at different times.
This makes cash-based accounting an attractive choice for businesses that do not have the resources to implement complex accounting systems.
Overall, cash-based accounting can be a useful tool for businesses looking to simplify their accounting and financial reporting processes.
How to choose whether accrual accounting or cash-based accounting is right for your business
So, which accounting method is right for your business? It depends on several factors, including the size and complexity of your business, the nature of your transactions, and your personal preferences.
Ultimately, it’s important to work with an experienced accountant to determine which method is best for your specific business.
With our help, you can be confident that you’re making the best decision for your company. We can help you to weigh up the pros and cons of each approach and choose the right one for your business.
If you have any questions about accrual vs. cash-based accounting, or if you need help setting up your financial systems, please don’t hesitate to contact your Johnsons MME advisor. We’re here to help.