Cash vs. Accrual Accounting: Differences Explained

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Cash vs. accrual accounting: pros and cons
Pros | Cons | Best for | |
---|---|---|---|
Cash basis accounting method |
|
| Very small businesses and sole proprietors with simple financials. |
Accrual basis accounting method |
|
| Small businesses that need to closely track accounts receivable, inventory or major liabilities, like loans. |
What is cash basis accounting?
Advantages of cash basis accounting
Disadvantages of cash basis accounting
- Cash basis accounting is not GAAP compliant: Cash basis accounting disregards the matching and revenue recognition principles of accounting. These principles are two of the generally accepted accounting principles, or GAAP, that are recognized as the foundation of good accounting practices. Publicly traded companies must follow GAAP, and small businesses applying for loans should too.
- Cash basis accounting doesn’t track accounts receivable and payable: If your business relies heavily on accounts receivable or accounts payable, cash basis accounting will not give you an accurate view of your business’s financial position. When you use the cash basis method of accounting, your outstanding bills owed to vendors don’t appear on your financial statements, nor do outstanding invoice balances customers owe you. Your cash basis financial statements might lead you to believe your business is highly profitable, when in fact you’re not even breaking even once you take your vendor’s bills into account.
What is accrual basis accounting?
Advantages of accrual basis accounting
Disadvantages of accrual basis accounting
- Accrual basis accounting can be time-consuming and difficult: It can take considerable effort to accurately keep accrual basis books, especially when it comes to expense matching. If you subscribe to a bookkeeping service, it may cost more to maintain accrual basis accounting records.
- If you’re a cash basis taxpayer, accrual accounting can obscure potential tax liabilities: Your tax preparer can easily convert your accrual basis statements to cash basis for tax purposes. But if you only look at your accrual basis accounting statements throughout the year, you could be in for a shock at tax time. Your accrual basis statements might show you haven’t earned much of a profit for the year, but your cash basis financial statements — which are used to file your tax return — could show a large profit, meaning you could have a large tax bill.
Cash vs. accrual accounting example
Should your small business use cash or accrual accounting?
- Do you need to track accounts receivable and payable? If so, accrual basis accounting is likely the better method.
- Do you plan on ever applying for a business loan? Lenders will want to see accrual basis financial statements. The accrual basis method of accounting will also more accurately reflect your liabilities if you end up taking out a loan.
- Does your business have significant inventory? If it does, cash basis accounting will likely not be sufficient.
- How long is the delay between when expenses are incurred and when they’re paid? How about when customers are billed versus when they pay you? If these events typically occur simultaneously, cash basis accounting may work just fine. If weeks or even months elapse, though, accrual basis accounting will better represent your business’s financial health.
Accounting software | Pricing | Best for |
---|---|---|
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Free. | Free, unlimited invoicing. | |
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