Accrual Basis vs. Cash Basis Accounting, Which one should I use?
Cash Basis Accounting
This method is based on the immediate recognition of revenue and expenses.
Revenue is reported on the income statement only when cash is received.
Expenses are only recorded when cash is paid out.
The cash method is mostly used by small businesses and for personal finances.
The downside to cash accounting is that it doesn’t show you how much money you have available to spend, because you’re not considering any future income or expenses.
Means revenue and expenses are recognized and recorded when they occur.
Expenses of goods and services are recorded despite no cash being paid out yet for those expenses but the products or services were already received.
Revenues are recorded in the time they occur even if the client/customer hasn't paid for it.
The accrual method is the most commonly used method, and it is required for publicly-traded companies as it smooths out earnings over time.
Advantages and Disadvantages of both methods.
Both methods have their advantages and disadvantages, and each only shows part of the financial situation of a company. Understanding both the accrual method and a company's cash flow with the cash method is important when making an investment decision.
Accrual Accounting vs. Cash Basis Accounting examples:
Let's say you own a business that sells computer machinery. If you sell $3,000 worth of machinery, under the cash method, that amount is not recorded in the books until the customer hands you the money or you receive the check. Under the accrual method, the $3,000 is recorded as revenue immediately when the sale is made, even if you receive the money a few days, weeks, or months later.
If you receive a bill for $800, under the cash method, the amount is not added to the books until you pay the bill. However, under the accrual method, the $800 is recorded as a bill the day you receive it.
Choosing which suits the best for your business depends on the information you want to have available on your financial statements. It is important to always seek an Accountant or Bookkeeper to analyze the best option for you when you are setting up your business or if you want to change from Cash to Accrual.
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