The main difference between cash accounting and accrual accounting can be found when you look at the timing of when the expenses and the revenue are recognised. The cash accounting method immediately recognises the expenses and revenue. The accrual method looks at the anticipated expenses and revenue.
What is cash accounting?
When cash accounting is used, any revenue is only accounted for when it has been received. Expenses are only ever recorded when the cash has been paid out. This method is typically used by small businesses and those who have an interest in their finances.
What is an example of cash accounting?
You own a business that sells musical instruments. If you sold £1,000 worth of instruments while using the cash method the money you receive won’t be recorded until the customer pays you.
What is accrual accounting?
Money or revenue is accounted for as soon as it is earned. The recording of the revenue takes place before any money is received. The accrual method will, in fact, record when the service or a product is delivered to a customer. When this happens, there is an expectation that the money will be paid to them in the near future. Therefore, the expenses surrounding the services or goods will be recorded. This is despite the fact that no cash has been paid out as yet.
Accrual accounting is typically used by publicly traded companies. This tends to be the case because the earnings are smoothed out over time.
What is an example of an accrual?
You own a business that sells musical instruments. If you sold $1,000 worth of instruments while using the accrual method the $1,000 will be recorded right away. This is the case even if you don’t receive the money for a few weeks.
Conclusion: what is the difference between cash and accrual accounting
Cash and accrual accounting differ in that cash accounting is considered to be a very simple way to record accounts. Accrual accounting offers a very accurate picture of how profitable a company is on a long-term basis.
Cash accounting does have its disadvantages despite it seeming a relatively easy way to work. This is because it may make the health of a company seem overstated. Therefore, someone who is looking to invest in the company might think it’s doing better than it really is. One of the disadvantages of accrual accounting is that it does not track the company’s cash flow. This means it might not account for a cash shortage, even though it looks to be quite profitable.
Both cash and accrual accounting have their benefits and their disadvantages. However, they both show just a section of the company’s financial health. Ensuring that you understand both kinds of accounting with respect to a company’s cash flow will help you should you wish to make an investment.