Accounting Basics: Cash Vs. Accrual

Having to handle the accounting functions of a new business is often the bane of the small business owner. Many new owners lack the skills and experience that may be necessary for their business venture. Some accounting terms in fact fly right over their heads. And because they do not understand the functions of accounting well enough there is a tendency to want to hand it over to someone else. But doing so may cause even more problems for you. Unless you understand a few basic concepts.

So to get your education in accounting underway you first need to understand the two basic methods of accounting. Cash-basis and accrual-basis accounting. Each one is uniquely different and if you plan on hiring an accountant to at least help you reconcile your books then it is imperative for you to know which one they plan to use. Or more specifically you need to tell them which one you want them to use. Some accountants prefer using one method over the other which could cause problems if that method is wrong for your business.

So what is cash-basis accounting? Simply put when you operate on a cash-basis then you record all of your transactions when you actually get paid. An easy example would be a hamburger stand. You sell a hamburger and somebody pays you in cash for the food. Then you record the transaction. You record payouts the same way. You don’t record the bill for the hamburger meat when you receive the bill but instead wait until you actually send out the money to pay that bill.

If your business offers payment terms to customers you can still use the cash-basis system. But you have to wait until you receive payment for the invoice you issued to record the sale. Over time as your business grows and more customers are invoiced regularly this system of accounting can become impractical due to the difficulty in tracking payments.

The other system of accounting in use is accrual-basis accounting. This system records transactions as they take place. When you invoice a customer or make a cash sale then the transaction is recorded. And of course when you receive a bill you record this transaction as well. It does not matter that the bill hasn’t been paid yet. Later when your invoice is paid or you pay a bill to your vendor then that payment will be recorded. With this system you also can record partial payments. And you have the ability to better track how many projects your business completed over a certain period of time.

Of course these explanations are only meant to give you a basic understanding of the difference between the two basic accounting methods. If you are not aware of them though you may run into problems with deciding which method is best for your business. Each method has further pros and con’s and pieces to understand. But you should understand each method thoroughly before deciding which to use.