Cash basis and accrual basis are two different methods of accounting used to record and report financial transactions. Cash basis displays income when cash is received. Accrual basis displays income when it is earned.
What is cash basis accounting?
Cash basis accounting is a straightforward method that recognizes transactions only when cash is received or paid. It does not consider credit sales or purchases or any non-cash transactions.
With this method:
- Income is recorded on the date payment is received from customers
- Expenses are recorded on the date the vendor is paid
What is accrual basis accounting?
Accrual basis accounting recognizes revenue when it is earned and expenses when they are incurred, regardless of when the cash is actually received or paid.
With this method:
- Income is recorded on the date of the invoice
- Expenses are recorded on the date of the bill
What is the key difference between cash basis and accrual basis accounting?
The key difference between the two lies in the timing of when revenues and expenses are recognized.
Cash basis accounting is simple and easy to understand, making it suitable for sole proprietors and small businesses with straightforward transactions. However, it may not provide an accurate representation of a company’s financial health or performance. This is because it does not consider revenue and expenses that have been earned or incurred but not yet paid or received.
Accrual basis accounting provides a more accurate representation of a company’s financial position and performance over a given period. It aligns revenues and expenses with the period in which they occur, offering a more comprehensive view of the business’s financial activity. It is the preferred method for most businesses, especially larger ones or those that need to follow generally accepted accounting principles (GAAP).
Deciding which method to use will depend on the size of your business and complexity of your financial transactions. When choosing your accounting method it is important to not only look at where your business is now, but to look at your future goals and plans for the growth and expansion of your business.