The main difference between the two is the timing in which the various accounting transactions are debited or credited to your accounts.
With the cash method, you don’t count the income until the money is actually received or paid. Here is a cash budget example: if you complete work for a client in November, but you don’t get paid until January, then you would record the income in your January books.
The cash method is beneficial because it helps you to understand the cash that is available, but it makes it harder to understand the long-term profitability of the company. For example, your books might show a big increase in revenue, even though that particular month was slow and the money came from delayed payments for work that was completed in prior months.
With the accrual method, the money is recorded from the moment the order is placed, regardless of when the payment is received. Using the same example as above, you would record the income in your November books even if you didn’t receive payment until January.
When you are using the accrual method, it helps you to see an accurate picture of the way your cash flow moves through the business, but it gets confusing when it comes time to understand the cash reserves that are available at any given moment.
Choosing YOUR Accounting Method
Once you have selected an accounting method it is best to stick with that same plan on an ongoing basis, because it can cause problems with your accounting records if you switch back and forth between the two methods. Most small businesses can use either type of accounting, but larger companies should be using the accrual method.
Are you a small business in Washington DC or another location? Myrick CPA offers small business accounting services for the local Washington DC area, as well as virtual services that are available for people anywhere in the United States. Contact us to learn more: (202) 789-8898