Accrual vs Cash-based Accounting
Cash and Accrual basis accounting are two major types of accounting that help businesses to manage their finances and prepare the taxes. You have to choose the right method that suits best for your business model.
Cash basis Accounting
In Cash basis accounting, the revenue is only recognized when the cash is received and the payment is paid. The transactions won’t be recognized as account receivables or account payables in cash base accounting. It is widely used by small businesses as it is much simpler than accrual. You only have to account when the transaction is made and, you don’t need to keep track of receivables and payables.
- Cash basis Accounting is easy to maintain as they will only record the transactions when its paid.
- Your income will only be taxed once it’s in your bank account, not when it is invoiced.
- It won’t always give you the accurate financial condition of your business. For example, your company might look profitable if you have a large sum of accounts payable and you haven’t yet paid them.
- It is hard to take managerial decisions when you have only limited insights. Cash basis accounting only gives you a day-to-day view of your finances.
Accrual Basis Accounting
In the Accrual basis of accounting, the revenue and expenses are recorded when they are earned, even it doesn’t matter when the payment is received or paid. This gives a realistic picture of your expenses and income over a period of time and provides a wider picture of the financial condition of your business than the cash basis method. But it doesn’t really provide any information about your cash flow. Your business might be profitable in the books but in reality, you might have huge cash crunches. The cash flow has to be carefully monitored and the payments should be done at the right time. Receivables need to be tracked accurately to maintain a steady cash flow. You might face huge consequences if you fail to monitor the cash flow properly.
- You can make sound financial decisions as you have more accurate insights into your business performances.
- It is easier to attract investors and bankers as the accrual basis of accounting provides a long-term view of your company’s finances.
- Accrual basis is more complicated compared to cash basis accounting.
- On accrual basis accounting, you might have to pay taxes on income that you are yet to receive. That is, you have to pay taxes for an invoice that has been already raised but the payment hasn’t been done yet.
Difference between Cash and Accrual basis accounting
The major difference between cash and accrual basis accounting is the time when the revenue and expenses are recognized. In cash basis accounting you will only recognize all the revenue when the money is received and the expenses are recognized when the money is spent. Whereas on the Accrual basis accounting, the revenue is recognized once when it’s earned.
Cash-based accounting is easier among the two. Hence, it is widely used by small businesses that are just getting started. Although, the transition from cash-based accounting to accrual accounting can be done easily when it is necessary.
An Accrual system is recommended if your business is complex and manages large assets. It will give an extensive idea about your company’s financial health by analyzing the accounts payables and receivables. IRS requires you to use the accrual method if your business gross is more than $5 million per year.
It is best to consult an Expert accountant to understand which method fits the best for your business. At Agile e-Platform, we provide the best business solutions customized for your business model which helps you grow in the market.