Accrual accounting offers a smarter solution by recording income and expenses when they occur, not just when cash is exchanged. In this section, we will explore the basic elements of cash and accrual accounting and the businesses that are most likely to use each one. Some private companies may choose to use cash-basis accounting rather than accrual-basis accounting to report financial information.
One of the easiest ways to start on the right foot is to get and use a dedicated business bank account. It creates a clear separation between personal and business finances – a distinction that protects you legally and makes tax preparation so much easier. As mentioned before, accrual accounting requires a solid understanding of principles like revenue recognition and expense matching. Invest in training your finance team, or consider hiring an experienced accountant to guide the process. Now, let’s compare accrual accounting with cash accounting to see how the two methods differ and help you decide which is best for your business. Expenses for the materials you bought to complete the job would be recorded in June when they were bought.
The two main types of accounting bases by which a business may prepare its financial statements are cash basis and accrual basis. The appropriate accounting method for a business depends on the type of business and that business’ need to track accounts receivable and accounts payable. Ultimately, this also plays a role in accurately determining the business’ value in a valuation.
This entry ensures your expenses match the month you used the supplies, even if payment hasn’t been made. Under the revenue recognition principle, you would record the revenue in August, when you fulfilled your obligation by delivering the furniture, even though you haven’t been paid yet. We provide third-party links as a convenience and for informational purposes only. Intuit does not endorse or approve these products and services, or the opinions of these corporations or organizations or individuals.
That’s not to say it can’t be changed later—only that it’s harder to switch once you get comfortable with one way or the other. Accounting software and tools like QuickBooks Live can help with either method, with virtual accountants available to help you every step of the way. Watch for growing complexity in your business—adding employees, expanding to new states, or dealing with inventory often means you’ll need professional support. When basic bookkeeping tasks start taking you away from revenue-generating activities, it’s time to evaluate outsourcing.
So now you know the difference between cash basis versus accrual accounting, it should be a bit clearer for you as to which accounting method you should use for your business. Finally, using the accrual basis of accounting, if cash is paid before incurring the expense, then no expense is recognized at that time. If accrual-basis accounting doesn’t measure how much cash is physically in your bank account, how is it more accurate than the cash method? Because instead of hyper-focusing on the exact time a transaction occurred, it focuses on what you earned and what you owed in a given period.
They invoice the client at the end of the month, with a payment deadline of October 31. Under the accrual basis, BluePrint records the revenue in September when the service was completed, not in October when payment is received. By recording cash vs accrual profit and loss accrued revenue, your financial statements show income in the period it was earned, helping you track profitability accurately, even if payment comes later. However, the cash basis method might overstate the health of a company that is cash-rich. That’s because it doesn’t record accounts payables that might exceed the cash on the books and the company’s current revenue stream. This means that if your business were to grow, your method of accounting would not need to change.
The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method provides an immediate recognition of revenue and expenses, while the accrual method focuses on anticipated revenue and expenses. With this method, you record income as it’s received and expenses as they’re paid. Cash basis accounting only records your expenses when money leaves your account to pay suppliers, vendors, and other third parties. Under the cash method, income is only recorded if the money is actually received. Similarly, expenses are recorded only if cash really left the bank account.
A good bookkeeper should be able to explain their processes clearly and demonstrate how they’ll add value to your business. If they don’t already work with your CPA, they should be willing to do that. There are a lot of tools that can help your business stay organized, and make bookkeeping easier.