Cash Basis vs Accrual Accounting: What's the Difference?

When it comes to accounting, there are two main methods that businesses can use: cash basis and accrual accounting. Each has its pros and cons, but which one is right for your business? In this blog post, we will discuss the differences between cash basis and accrual accounting so that you can make the best decision for your company.

What is Cash Basis Accounting?

Cash basis accounting is the most simple and straightforward method of accounting. With cash basis accounting, you only record transactions when money changes hands. So, if you sell a product or service on credit, you wouldn't record that sale until the customer actually pays you.

The Pros of Cash Basis Accounting

Many small businesses choose cash basis accounting because it's less complicated than accrual accounting. It can also make it easier to track your cash flow, which is a big bonus for many small businesses.

The Cons of Cash Basis Accounting

However, there are also some drawbacks to using cash basis accounting. For example, if you sell a lot of products or services on credit, your income may appear artificially low. This can make  it difficult to get loans or other forms of financing. Additionally, you may have a hard time budgeting and forecasting because your income can fluctuate greatly from month to month.

What is Accrual Accounting?

Accrual accounting is a more complex method of accounting than cash basis accounting. With accrual accounting, you record transactions when they occur, regardless of when the money changes hands. So if you sell a product or service on credit, you would record the sale as soon as the transaction takes place.

Accrual accounting is generally considered the gold standard of  accounting because it provides a more accurate picture of your financial situation.

In most countries, businesses with a turnover above a certain threshold must use accrual accounting. 

In the UK, for example, registered companies that turnover more than £150,000 per year are required to use accrual accounting. In the USA, publicly traded companies and businesses that earn over $26 million in a three-year period must use accrual accounting.

The Pros of Accrual Accounting

One of the biggest advantages of accrual accounting is that it provides a more accurate picture of your business's financial health. This is because it includes all revenue and expenses, even if they  haven't been paid yet. This can be helpful  when you're trying to get a loan or other form of financing. Additionally, accrual accounting can make it easier to budget and forecast.

The Cons of Accrual Accounting

However, there are also some drawbacks to using accrual accounting. The primary one is that it's generally more complex than cash basis accounting.

Additionally, you may have to pay taxes on revenue that you haven't actually received yet. However with accrual accounting you are able to write off bad debts and deduct them from your tax bill.

Which One to Choose

So, which accounting method is right for your business? In truth, there is no one-size-fits all. The answer depends on a variety of factors, including the size and complexity of your business and your personal preferences. For example, if your business relies heavily upon cash payments, then cash basis accounting may be a better option. However, if you frequently use and/or extend credit, then the accrual may be a better fit.

Ultimately, the best way to decide is by speaking to an accountant or financial advisor who knows your business and industry inside-out, and seeing which method they recommend.