Cash Accounting Vs Accrual Accounting: Which Is Better?

If cash accounting allows a better insight of cash inflow, it is accrual accounting that provides a clear picture of profitability in a business. Both have their limitations and both are winners as per an individual’s needs.

— Cash Accounting Vs. Accrual Accounting

If cash accounting allows a better insight of cash inflow, it is accrual accounting that provides a clear picture of profitability in a business. Both have their limitations and both are winners as per an individual’s needs.

In a nutshell, both these accounting methods only differ in one thing – the timing of entries to the book. Cash accounting considers receivables and payables only when they are received or paid, i.e when the cash is exchanged, while accrual accounting considers transactions as they happen, no matter when the money is received or paid.

While in cash accounting you have to wait to receive the payment or pay for an expense to report it in the books, in accrual accounting you must report it only once the service is delivered. Under the cash accounting method, bookkeeper can track the date when the money is paid or received, but accrual accounting helps in tracking the time of completion of a deal.

Why Accrual Accounting is Everybody’s Favorite?

As the revenues and expenses are reported when they occur in accrual accounting, this method provides a detailed and clear picture of cash flow of a business for an accounting period. It uses double entry bookkeeping system and for businesses that sell services and receive payments later, accrual accounting is ideal.

Despite the fact that accrual accounting provides a clear picture of cash flow and profitability of a business, small business owners must monitor cash flow more carefully to scrutinize the position of their business.

While using accrual accounting your business may look profitable for a particular month, but your bank account might say a different story if the payment gets late. This method of accounting is not ideal if you have customers who need to be pushed to pay. For this you must monitor cash flow and chase payments regularly.

Should I Use Cash Accounting?

Cash basis accounting reports revenues when they are received and paid. It uses single entry bookkeeping system and is pretty easy to maintain. As cash accounting method helps in recognizing the time of the transaction, it eliminates the need to track receivables and payables. It also helps in finding out the amount of cash a business has on hand at any given time. Cash accounting method cannot be used if your business sells products on credit; accrual method is much better for this.

Small business owners generally begin by using cash accounting method but switch to accrual accounting after some time, as cash accounting method only projects the cash flow and leaves out other aspects of bookkeeping like matching earned revenues with expenses incurred for a specific accounting period. As you eventually have to switch to accrual accounting once you expand your operations, so why don’t do it from the start?

Both these methods have their drawbacks and its ideal to select as per your needs. You might like to go for accrual accounting if your annual revenue is more than $5 million, however it’s better to seek expert opinion before settling on considering any accounting method.

What do you think? Which accounting system do you follow? Which accounting do you find beneficial and easy to use?