How to Decide Between Cash and Accrual Accounting for your Business

Accounting has long surpassed the bean counter, and new business owners are well-advised to consult a professional on complex issues. Still, there are fundamental accounting decisions you can make for your business, even if you're a finance novice. One of these is choosing between a cash and accrual system of accounting. Following these steps will help you make the right choice.


  1. Image titled Decide Between Cash and Accrual Accounting for your Business Step 1
    Differentiate between the cash and accrual accounting methods for your business. You need not have great accounting or business acumen, but you most definitely need to have an understanding of each system in order to make a decision that is right for you. Some business models are not even possible for one method versus the other.
    • In cash-basis accounting, you will record expenses in your ledger when you actually hand over your cash to the vendor. Conversely, when you record revenue in your financial sheets is when you actually get cash into your pocket. This method was probably normal and customary back in the day when credit cards were not yet invented. As an example, you are a sub contractor on a project that you actually finished in December of 2010, but your client did not pay you until the end of January 2011. You would book that revenue and claim it on your 2011 taxes, though the work was actually completed in 2010.
    • In an accrual accounting system, you will record expenses in your ledger when they actually occur, for example, the day you receive your carpentry tools, not necessarily when you pay the bill. On the other hand, you will record revenue in your financial sheets when you complete that kitchen remodel project for your client, not when your client actually gets around to paying you. Using the previous example in the cash-basis explanation, you would record and claim your revenue in 2010 for the work you completed in December, even though you did not stick the cash in your pocket until January of 2011.
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    Choose which system is right for you and your business. There are distinct advantages and disadvantages to each system. Having a clear understanding of these will greatly aid in your decision making process.
    • An advantage of the cash-basis system is that it is the system for tracking how much cash you actually have on hand. You always know because you only record it when you are getting it or giving it away.
    • The big disadvantage of the cash-basis system is that it is a poor system for tracking historical growth. It is difficult to tell when you had a good month or a bad month or to see year over year sales. This is because the time that the transaction actually took place could be months prior to when you actually received or paid cash out and again, the transaction is recorded only when the cash actually changes hands.
    • An advantage of the accrual system is that it is great for tracking the health of your business and building historical trends. Expenses and revenues are each matched within the month that they took place, not months later when the cash actually changed hands. So you can easily tell how you are doing month over month or year over year.
    • The main disadvantage of the accrual system of course, is that you can never really tell how much cash is in your pocket. Your bank account may be full, but you might have expenses that haven't been paid for yet. Likewise, things might be looking bleak for you, there may be a lot of unpaid revenues awaiting.
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    Decide on the business model and how you will operate. Some business models will absolutely not work with one system over the other.
    • If you purchase inventory on credit and then pay your purchase invoice after you have actually sold the inventory and made your profit, you cannot use cash-basis accounting. The cash hasn't actually passed from hand to hand at the time that you purchased your inventory. On the other hand, if you allow sales to your customers on credit, that is, you allow them to pay you at a later date, the same rule applies. This is an accrual methodology.
    • If you do not plan on extending credit to anyone or accepting credit cards for payment; or will only accept cash or checks the cash basis system is right for you. If you plan on operating this way, you have to understand that you cannot use credit to purchase inventory, supplies or stock either.


  • An additional advantage of the cash-basis system is that you can purposefully delay your revenue stream by asking clients hold off on paying you for as long as you wish. This is beneficial if you need to lower your tax debt for one year and can hold off receiving funds until the following year.

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Categories: Business | Accounting and Regulations