- How Does Cash Basis Accounting Work?
- How Does Accrual Accounting Work?
- Cash vs. Accrual Workflow Examples
- How Cash Accounting and Accrual Basis of Accounting Impact Taxes
- Who Uses Cash vs. Accrual Accounting?
- Cash vs. Accrual Accounting Takeaways
How Does Cash Basis Accounting Work?You can think of cash basis accounting as how you might manage your own personal finances — cash in and cash out. As you purchase groceries from the store, money is (likely) withdrawn from your debit account immediately — and when payday rolls around, the funds from your paycheck are deposited into that same account. This deposit makes up for the money taken out when you bought groceries. The same idea applies when businesses operate on a cash basis of accounting. They recognize the revenue and expenses as they happen, which gives them a good idea of how much cash they currently have at their disposal. Because cash accounting recognizes revenue and expenses right as money is received and withdrawn, cash accounting gives you a good at-a-glance perspective of what’s actually in your bank account at any given moment. Some businesses choose to use cash accounting because it is easy to manage and convenient to make a decision on what you can and can’t afford. On the other hand, cash accounting can limit how businesses plan for the future, and might be unrealistic if your business is constantly sending and receiving invoices as part of business operations.
Advantages of cash accounting
- Simple and quick accounting
- Accurate representation of cash flow
- Less staff and financial resources
- Can sometimes provide tax benefits
Disadvantages of cash accounting
- Not a great indicator of long term trends
- Does not account for payments that cannot be made immediately
How Does Accrual Accounting Work?Accrual accounting is more commonly used for business accounting than the cash based accounting method. Rather than recording income and expenses as the funds are actually being processed, the accrual basis of accounting tracks transactions as they are billed and earned. This does not take into account whether the funds have been taken out of the account — or if they’ve been deposited, but rather counts on these transactions as events that will happen. Think about the days before venmo and other cash transfer apps when you wrote your friends “IOUs” as a promise to pay them back. Accrual accounting works on this same philosophy by recording transactions and assuming that the payment has already happened.
Advantages of accrual accounting
- Presents a more accurate picture of how a business is performing in the long term
- Can be a more realistic model for businesses that invoice customers
Disadvantages of accrual accounting
- More complex than cash basis accounting
- Income taxes may be owed on revenue before payment has been received
- Less visibility into actual cash flow