The difference between cash and accrual accounting methods

 As a small business owner, one of the most important decisions you'll make is choosing the right accounting method. But with so many options available, it can be difficult to know where to start.

At Taxstra, our team of certified public accountants (CPAs) has helped countless businesses choose the best accounting method for their unique needs. In this article, we'll explain the difference between two of the most commonly used methods: cash accounting and accrual accounting.

What is cash accounting?

Cash accounting, also known as cash basis accounting, is a method of accounting that recognizes revenue and expenses only when cash is received or paid. In other words, revenue is recorded when it is received, and expenses are recorded when they are paid.

For example, if you sell a product for $100 on January 1, but don't receive payment until January 15, the sale will not be recorded in your financial statements until January 15. Similarly, if you incur an expense of $50 on December 31, but don't pay it until January 10, the expense will not be recorded in your financial statements until January 10.

Cash accounting is simple and straightforward, which makes it a good choice for small businesses with limited resources. However, it has some limitations, which we'll discuss later in this article.

What is accrual accounting?

Accrual accounting, also known as accrual basis accounting, is a method of accounting that recognizes revenue and expenses when they are earned or incurred, regardless of when cash is received or paid. In other words, revenue is recorded when it is earned, and expenses are recorded when they are incurred.

For example, using the same scenario as above, if you sell a product for $100 on January 1, the sale will be recorded in your financial statements on January 1, even if you don't receive payment until January 15. Similarly, if you incur an expense of $50 on December 31, the expense will be recorded in your financial statements on December 31, even if you don't pay it until January 10.

Accrual accounting provides a more accurate picture of a business's financial performance, as it reflects the true economic activity of the business. However, it can be more complex and time-consuming than cash accounting.

Which method is best for my business?

The right accounting method for your business will depend on a number of factors, including the size and complexity of your business, the type of industry you're in, and your personal preferences.

Here are a few key differences between cash and accrual accounting to help you decide which method is best for your business:

• Timing: As we discussed earlier, the main difference between cash and accrual accounting is the timing of when revenue and expenses are recorded. Cash accounting recognizes revenue and expenses when cash is received or paid, while accrual accounting recognizes them when they are earned or incurred.
• Matching principle: The matching principle is a fundamental principle of accrual accounting that states that revenue and expenses should be recorded in the same period to provide an accurate picture of a business's financial performance. For example, if a business sells a product on credit, the revenue from the sale should be recorded in the same period as the cost of the product, even if cash is not received until a later period. This is not possible with cash accounting, which only recognizes revenue and expenses when cash is received or paid.
• Taxation: The timing of when revenue and expenses are recognized can also have an impact on your tax liability. With cash accounting, you may not be required to pay taxes on revenue until it is received, which can provide some short-term cash flow benefits. However with accrual accounting, you may be required to pay taxes on revenue when it is earned, even if you haven't received payment yet. This can be a disadvantage if you're not able to pay the taxes immediately.
• Limitations: As mentioned earlier, cash accounting has some limitations. For example, it may not provide an accurate picture of a business's financial performance if there are significant differences between when revenue is earned and when cash is received, or between when expenses are incurred and when cash is paid. Additionally, cash accounting may not be suitable for businesses that operate on a global scale, as it does not account for differences in currency or exchange rates.

In conclusion, choosing the right accounting method for your business is an important decision that should not be taken lightly. Both cash and accrual accounting have their advantages and disadvantages, and the right method for your business will depend on your specific needs and goals.

If you need help deciding which accounting method is best for your business, or if you would like to discuss your accounting needs with a CPA, contact Taxstra today at 217.788.0750 or visit our website www.taxstra.com. As a top accounting firm in Springfield, IL, we are dedicated to helping businesses succeed.