Although the different kinds of accounting methods is not exactly an exhilarating topic for most, there are some things you should be aware off in order to keep proper track of your business’ finances.

Here we will break down the difference between the two methods and what the benefits are for each.

So, What’s The Difference

The most important difference between the cash-basis and accrual-basis accounting is the timing of when your business income and expenses are recorded in the books.

Cash-Basis Accounting

This method is simple ans straightforward, however keep in mind that this method is not acceptable under the Generally Acceptable Accounting Principles (GAAP) or the International Financial Reporting Standards (IFRS). Under this method, income is recorded only when your business actually receives payment for products or services and expenses are recorded when you pay for products/services.

Let me give you an example: Let’s assume you own a mechanic shop and you’ve just finished work changing the tires on a client’s vehicle and have billed them for this service. Under the cash-basis, you can only record this income earned is only recorded when your client actually pays (when money changes hands) you. So if you bill the client on June 15th and your client doesn’t pay until July 7th, that income will not be recorded until July 7th.

Similarly, if you receive a utility bill, you would not record that expense until you actually pay for the bill. If you received the invoice on July 15th and didn’t pay for it until August 1st, that expense would not be recorded until August 1st.

Accrual-Basis Accounting

Accrual-basis accounting is a bit more complex than the cash-basis, but is the method most used by most businesses. In accrual-basis accounting, your income is recognized when it is earned and expenses are recognized when you receive a bill.

Here’s an example, imagine you business has been hired to provide marketing services for a client. You would record income earned as soon as the service is complete—even if your client has yet to pay the invoice. So if you completed the work on September 16th, but the client doesn’t pay until November 2nd, you would still record the income earned on September 16th.

The same logic applies for your expenses. If you receive an cell phone bill, that expense is recorded as soon as the bill comes in—even if it’s not yet paid. So if the phone bill arrives February 14th and you pay on the bill on March 1st, the expense is still recorded on February 14th.

Benefits and Drawbacks

You’re probably wondering at this point what the benefits and drawbacks are to each method. Below, we cover the benefits and disadvantages of the two methods.

Cash-Basis Benefits

• Simplicity and ease. This method is straightforward because there is no need to track your receivables or payables. It’s easy to track income and expenses as you receive and spend cash.

• It saves you money on taxes; you only pay taxes on income actually received and not on invoices you have yet to collect payment for.

• It makes it easier for you to track your business financial status. It gives a better day to day snapshot of how much cash your business actually has.

Cash-Basis Disadvantages

• This method can be misleading by showing that your business is more/less profitable because of payments that either hasn’t been collected or issued.

• Businesses need more than a day to day snapshot of their finances in order to make effective business decisions, this method is not very helpful when planning for your business at the long-term.

Accrual-Basis Benefits

• It provides an accurate picture of your business performance.

• Helpful in making business decisions because you can rely on and be confident about your business’ financial position.

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