Accounting Advice

What is the Difference between Cash and Accrual Basis Accounting?

Cash Versus Accrual Basis Accounting

“Do you do cash or accrual based accounting?” is a common question we get from prospective clients. More often than not, they aren’t entirely sure why they’re asking but they know only one of them relates to them and their business needs. The short answer is yes, we do. Accountfully works with businesses of all sizes and industries. As such, we have to have the capabilities and resources to handle both cash and accrual based accounting.

For all of our clients, we use accrual based accounting for financial reporting, decision making, and for advising on big decisions. We then determine which is best for tax purposes and can make proper adjustments if we think it would have a meaningful impact on the client—that’s what a true partner does. To take it a step further, we can help our clients transition from one method to the other if it makes sense for their business. (This would involve filing a form with the IRS, but that’s something we can address down the road.) 

We appreciate the fact that most business owners, especially those new to entrepreneurship, don’t dream about bookkeeping and accounting logistics while getting their ventures off the ground. For this reason it’s important they work with an outsourced accounting firm. A good outsourced accounting firm will educate business owners and help them understand the pros and cons of of things like selecting cash vs accrual based accounting. Today we’re looking at the differences between the two methods and their tax implications.

The main difference between cash and accrual accounting is when and how revenues and expenses are recorded.

Cash Basis Accounting

With cash basis accounting, revenues are recorded when cash is technically received. Expenses, regardless of when they were incurred, are recorded when they are actually paid.

Many small businesses and sole proprietorships elect the cash-based accounting method due to its ease with managing cash flow–there isn’t any need to manage accounts receivable and accounts payable. Instead, it’s looking at the bank account to understand the financial health of the business.

Accrual Basis Accounting

With accrual basis accounting, revenues and expenses are recorded when they are earned and incurred—not when the actual money is received or paid.

With the accrual method, business owners can get a better long-term picture of the business because month-over-month results aren’t skewed by when money comes in or out.

Some business types have no choice about their accounting method. If it is a business carries inventory and sells merchandise (looking at you CPG and food entrepreneurs), the accrual method will need to be adopted since it will likely be extending credit to customers.

Tax Considerations

Accounting methods can also have tax implications for business owners to think about. For example, if your fiscal year is the end of December and you don’t receive payment until January, under the accrual method, the payment would be included as revenue in the prior year because it was work that was completed and invoiced for. Under the cash method, the revenue would be recognized in the new year because that’s when it was technically received. Working with an accounting firm that has a tax department will help you understand your tax implications and how the day-to-day bookkeeping lends itself to the greater tax picture. Accountfully goes a step further and offers a wide range of tax packages so clients can proactively plan for tax filing.

Whether your business is better suited for cash or accrual based accounting is something you should be able to articulate. If you can’t—ask a partner who can help you make sense of things—be the best business owner you can. That starts with building your team.
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