Cash vs Accrual Accounting: Which Accounting Method Is Right for Your Business?

Cash basis accounting records income when you receive it and expenses when you pay them, while accrual accounting records them when they are earned or owed, no matter when the money moves.

Imagine you finish a job in one month and send an invoice, and the customer pays the next month.  On the cash basis, the income belongs to the month the payment arrives.  On the accrual basis, it belongs to the month you did the work.

The same logic applies to bills.  A supplier invoice you receive now but pay later counts as an expense right away under accrual, and only on payment day under cash.

Neither method is more honest than the other.  They are two ways of drawing the same picture, and each gives a different view of a particular month.

Many small businesses and self-employed people use the cash method because it is simple and follows their bank account, but the right choice depends on your business.

The cash method tends to suit people who are paid at or near the time of service and who do not carry inventory.  Your bank activity and your books stay close to each other, which also makes it easier to reconcile your accounts.

Accrual can suit a business that sells on credit, holds inventory, or wants a steadier view of profit.  Lenders and outside investors sometimes ask for accrual statements for that reason.

The tax rules also matter.  The IRS restricts which methods certain businesses may use, depending on factors such as the type of entity, whether inventory is involved, and how large the business is.  Those rules change, so we confirm the current ones before recommending anything.

• Do you carry inventory that you buy and resell?
• Do customers usually pay you well after the work is finished?
• Do you need financial statements for a bank, a buyer or an investor?
• What type of business entity do you have? See business tax return types.
• Do you want the simplest possible record keeping?

Cash basis needs a reliable log of money in and money out, while accrual also needs a running list of what customers owe you and what you owe others.

Under the cash method, your bank statements, deposits and receipts do most of the work.  Consistent receipt and expense tracking is the foundation.

Under accrual, you also keep records of invoices sent (accounts receivable) and bills received but not yet paid (accounts payable).  Those feed your profit and loss statement and balance sheet.

Either way, choose one system, apply it the same way every month, and write down what you chose so anyone helping you follows the same rules.

Melton Tax Services can talk through the choice as part of our tax planning and consulting service.

We can look at how your business earns and spends money, explain how each method would treat it, and confirm the current rules that apply to your situation before you commit.

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