When setting up a financial system, one of the first decisions a business must make is whether to use cash basis accounting or accrual basis accounting. The choice impacts everything from how profits are measured to how taxes are filed, so it’s important to understand the difference.
Cash Basis Accounting
Cash accounting is simple: income and expenses are recorded only when money actually changes hands.
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Revenue is recognized when you receive payment.
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Expenses are recorded when you pay bills.
For example, if you invoice a client in July but don’t get paid until August, you wouldn’t record the income until August.
This method is straightforward and gives a clear picture of cash flow, making it popular with small businesses and freelancers. However, it can paint an incomplete picture of profitability, since it ignores unpaid invoices and outstanding obligations.
Accrual Basis Accounting
Accrual accounting provides a more comprehensive view.
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Revenue is recognized when it’s earned, not when payment is received.
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Expenses are recorded when they’re incurred, even if payment hasn’t been made yet.
In the July invoice example, the revenue would be recorded in July, when the service was provided, even if payment doesn’t arrive until August.
This method aligns with Generally Accepted Accounting Principles (GAAP) and is required for many larger businesses. It offers a truer picture of financial performance but can be more complex to manage.
Which Method Should You Choose?
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Cash basis is best for smaller businesses that want simplicity and a close focus on cash flow.
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Accrual basis is better for growing companies that need accurate reporting and long-term insights.
Some businesses even use a hybrid approach—tracking daily operations with cash accounting while preparing financial statements using accrual.
Takeaway: Cash accounting shows what’s in your pocket today. Accrual accounting shows the bigger picture of profitability. The right choice depends on your business’s size, goals, and reporting needs.
The Dolins Group provides accounting and consulting to closely-held businesses, individuals and families. Contact us today for a free consultation.