How to Choose between Cash vs. Accrual Accounting for Your Business

Are you unsure if cash or accrual accounting would be the best method of accounting for your business? While this can seem like an overwhelming decision to make, it really comes down to a few key differences.

Cash accounting recognizes revenues and expenses at the time cash is received or paid out. Using this method, the business is provided with a clear picture of how much money they have on hand. This is ideal for small business owners because it is more straightforward than accrual accounting due to recording items only when money is exchanged. The drawback to this method is that it does not account for any receivables or payables and could make the company appear to be in a better or worse position than it is, which can make lenders less likely to provide the business with financing.

Accrual accounting recognizes revenues and expenses when the service is performed. This means that a company can record revenue and expenses without money being exchanged at that time. Through this method, the business is provided with a clear picture of where they stand because they can see the receivables and payables that the company has outstanding. Businesses with over $25 million in annual gross receipts must use the accrual method, as well as C corporations, tax shelters, certain types of trusts, and partnerships that have C Corporation partners.

Let’s look at an example of cash vs. accrual accounting:

A lawncare company provides a $500 service to a client on May 1^st. The client received the bill for the services rendered and made a payment on June 3^rd. Under the cash basis of accounting the lawncare company would record $500 in revenue when it is paid on June 3^rd. On the flip side in accrual accounting, the lawncare company would record a receivable of $500 on May 1^st, when the service was provided, and then record the revenue of $500 on June 3^rd when the payment was received.

In the above example we see that under the cash basis of accounting the lawncare business would not reflect the $500 on their books until the money had been exchanged. This means that until the payment was received, the business did not recognize the revenue. Whereas in the accrual method the business recognized the revenue immediately after and the books reflected the $500 owed to them.

In conclusion, the difference between cash and accrual accounting is when revenue and expenses are recognized by the business. It would be best for a business who wants to have a clear picture of cash on hand and does not have long-term liabilities to use a cash basis. Accrual accounting would be better for a company that wants to have an accurate picture of the business and will need to track long-term liabilities and inventory.

This article was written by Julie Howard. Julie is an Accounting Specialist I with Baldwin CPAs. For more information on the support Baldwin CPAs can provide you, contact julie.howard@baldwincpas.com.