What is Cash vs. Accrual Accounting?
The Short Answer
Cash vs. Accrual Accounting explained simply
Cash accounting is simple. You record income when you get the cash and expenses when you pay the cash. It’s like balancing your personal checkbook. Accrual accounting is a bit more complex. You record income when you earn it, even if the customer hasn’t paid yet. You record expenses when you incur them, even if you haven’t paid the bill yet. Most larger businesses and those with inventory use accrual accounting because it gives a clearer picture of long-term financial performance.
Real-World Example
The Freelance Designer Example
Imagine a freelance designer finishes a project in December but doesn't get paid until January.
Cash Accounting: The income is recorded in January when the cash is received.
Accrual Accounting: The income is recorded in December when the work was completed and earned, even though the payment comes later.
Why this matters
The choice between cash and accrual accounting affects how your business's financial statements look. This impacts how buyers and lenders view your business. Accrual accounting generally provides a more accurate picture of a business's profitability over time, which is important for valuation and securing financing.
Most small businesses start with cash accounting because it’s easier. But as you grow, especially if you have inventory or offer credit, switching to accrual accounting gives a more accurate view of your business's true financial health. This is crucial when you’re preparing to sell.
Most small businesses start with cash accounting because it’s easier. But as you grow, especially if you have inventory or offer credit, switching to accrual accounting gives a more accurate view of your business's true financial health. This is crucial when you’re preparing to sell.
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