Cash vs. Accrual Accounting: Which Should You Choose?
April 1 2016
No matter if you hire a professional to handle your business finances or go the do-it-yourself route, it's important to understand the differences between cash and accrual accounting.
Cash-based accounting records revenues when cash is received and expenses when paid. With cash-based accounting, you don't need to concern yourself with accounts receivables and accounts payables.
The main benefit to cash-based accounting is its simplicity to maintain -- money is either in the bank or out of the bank. Because of this, a business can see how much cash it actually has at any given time.
Accrual-based accounting records revenues when they are earned, regardless of when the money is actually received. In the same way, expenses are recorded when the bill is generated, not when the bill is actually paid.
Accrual accounting is more commonly used by business because it gives a more realistic picture of income and expenses during a given period of time. In addition, it provides a clearer long-term picture of the health of the business finances that cash accounting just can't do.
The drawback to the accrual method is the fact that it doesn't provide an awareness of cash flow. A business can seem profitable when the coffers are in fact empty. If cash flow is ignored, it can be detrimental to the business.
With cash accounting, income is recorded when received. For example, projects invoiced in November and December will not be considered taxable income if your clients don't pay until January. With the accrual method, any projects invoiced in November and December will be taxed for that year, whether or not the clients pay then or not.
Depending on the type of business you have, you may be required by the IRS to use the accrual-based method. This usually applies to businesses with inventories.
To determine the best fit for your business, consult your accountant or outsourced CFO. Because both methods have their limitations, your accounting professional can work with you so that no matter which method you choose, you always know the true story your numbers tell.
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