Accrual-based accounting and cash-based accounting are two different methods of recording financial transactions. The main difference between the two methods is the timing of when revenue and expenses are recognized.
In cash-based accounting, revenue and expenses are recognized only when cash is received or paid out. This means that if a company sells a product on credit, the revenue is not recognized until the customer pays for the product. Similarly, if a company incurs an expense but does not pay for it immediately, the expense is not recognized until it is paid.
On the other hand, accrual accounting recognizes revenue and expenses when they are earned or incurred, regardless of whether cash has been exchanged. This means that if a company sells a product on credit, the revenue is recognized at the time of sale, even though the customer has not yet paid. Similarly, if a company incurs an expense but does not pay for it immediately, the expense is recognized when it is incurred.
5 Benefits of Accrual Based Accounting
Accurate financial reporting: Accrual accounting provides a more accurate picture of a company's financial performance over time by matching revenue and expenses to the period in which they were earned or incurred. This can help a company make more informed decisions about its finances and operations.
Better management of cash flow: Accrual accounting allows a company to anticipate its revenue and expenses, which can help it better manage its cash flow. This can be especially important for small businesses with limited cash reserves.
Compliance with accounting standards: Accrual accounting is the preferred method of accounting under generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). By using accrual accounting, a company can ensure its financial statements comply with these accounting standards.
More accurate financial analysis: Accrual accounting allows for more accurate financial analysis by providing a more complete picture of a company's financial performance. This can be useful for investors, lenders, and other stakeholders who are interested in understanding a company's financial position.
Better tax planning: Accrual accounting can help a company plan for taxes more effectively by allowing it to anticipate its income and expenses. This can help a company manage its tax liability and avoid any surprises at tax time.
Work with Accrual Based Accounting and Report with Cash Basis Accounting
For the best of both worlds, use a program like Quickbooks (check out Quickbooks Online vs. Quickbooks Desktop). During the year, you can record transactions and run reports that show an accurate picture of your business based on the accrual method. At the end of the year, when it is time to do your taxes, you can run all the reports using the cash basis option. Quickbooks will make all the adjustments and give you the reports for filing your taxes.
Overall, while cash-based accounting may be simpler for small businesses, accrual accounting provides a more accurate picture of financial performance, compliance with accounting standards, improved cash flow management, and more accurate financial reporting.