Accrual Accounting vs. Cash Accounting - Both Matter.
Written By Mary Johnson, Cleanup Specialist at BEC CFO & CPA
Accrual accounting and cash accounting both matter because they provide different perspectives on a company's financial health and performance. Each method has its own strengths and is suitable for different situations:
Accrual Accounting:
Provides a More Accurate Picture
Accrual accounting recognizes revenues and expenses when they are incurred, regardless of when cash transactions occur. This method matches income and expenses to the period in which they are earned or incurred, giving a more accurate picture of a company’s financial performance and position.
What does this mean?
Revenue is booked the day you invoice your client, or the day your client is supposed to pay. For example – in Real Estate accounting you would book Rental Income at the beginning of the month. Then, apply the payment when it is paid. By doing this – you can review any tenant that is consistently late paying.
Expenses are booked the day you are required to pay.
You would input the bill into your accounting program, date the bill based on the bill date, then pay the bill vs writing a check and recognizing the check when it clears your bank.
Useful for Financial Reporting
It aligns with generally accepted accounting principles (GAAP). This approach is useful for stakeholders who need a comprehensive understanding of financial performance, such as investors, creditors, and analysts.
Accrual Accounting also gives insight into profit margins. If you have rental real estate properties – Income minus the expenses – is your profit margin. The profit margin by property will let you know if you are charging an acceptable rent.
Cash Accounting:
Simplicity and Directness
Cash accounting records transactions only when cash is exchanged. This simplicity makes it easier for small businesses or sole proprietors to maintain their books without the complexity of accrual accounting.
Immediate Insight into Cash Flow
It provides a clear view of how much cash is on hand, which is crucial for managing daily operations and ensuring the business can meet its short-term obligations.
When you run an Income Statement using Cash Basis Accounting – you gain quick insight into operating net income.
Tax Benefits
For tax purposes, some smaller businesses might prefer cash accounting because it lets them report income and expenses when they receive or pay out cash, potentially deferring tax liabilities.
Conclusion
Both are needed and useful to review. For most small business owners – Accrual and Cash Basis accounting are normally not significantly different.