Cash and accrual are the two primary choices for business accounting. When you start a small business, you’ll need to decide which method to use to best track your business finances. The difference between cash and accrual accounting is the timing of when sales and purchases are recorded in your accounts.
With cash accounting, you report expenses when you pay them and income when someone pays you. This system of accounting recognizes revenue and expenses only when money changes hands.
Accrual accounting matches revenues to expenses at the time in which the transaction occurs rather than when payment is made or received. This method allows the current cash inflows or outflows to be combined with future expected cash inflows or outflows to give a more accurate picture of a company's current financial position.
Investopedia outlines how the accrual and cash method differ:
The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is a more immediate recognition of revenue and expenses, while the accrual method focuses on anticipated revenue and expenses.
Pros of the cash method include:
Despite the benefits, there are cons to using cash-basis accounting. Consider the following before committing to one method.
When transitioning your accounting books from cash to accrual, you must:
If you’re choosing an accounting method, here are the benefits of using an accrual method:
Here are details about the accrual method to consider.
If your business is a corporation (other than an S corp) that averages more than $25 million in gross receipts each year, the IRS requires you to use the accrual method. If your business doesn’t hit those criteria, the cash method should be used.
However, the cash method usually works better for smaller businesses without inventory. If you’re an inventory-heavy business, your accountant will probably recommend you go with the accrual method.
To change accounting methods, you need to file Form 3115 to get approval from the IRS. File this form to request a change in either an overall method of accounting or the accounting of any item.