Accounting is the process of recording financial transactions for businesses. This includes recording, classifying, and summarizing reports before submitting them to regulators and tax collectors. The financial statements used in accounting are a summary over an accounting period with regards to company operations, financial position, and cash flows.
What is the difference between the cash basis and the accrual basis? Read on to find out more…
Cash basis accounting
Cash basis accounting is based on the cash activity in your business. It’s the most basic form of accounting where you record revenue from cash receipts and expenses when you pay sellers and employees. When you study your bank balance it’ll give you an instant amount of money at your disposal.
Although this method is simple and easy to maintain the cash basis of accounting won’t give a true reflection of the financial state of the business. As an example, if the money in the bank is actually needed to pay upcoming expenses this gives a false impression of how much money is available for spending.
Accrual basis accounting
The accrual concept in accounting is the matching of revenue with expenses in the same period in which the money was earned and the expenses actually occurred. Entries are made on a monthly basis, and accruals of expenses that occurred during that month but might not have yet been paid are accounted for.
By opting for this method monies can be allocated to the correct period giving a more accurate analysis of how your business is performing. An example would be of an invoice already sent to a customer – the amount would be recorded as owed revenue – as the customer hasn’t yet paid.
Accrual accounting will provide a more realistic financial view of a business over the long term. As the system tends to be more complex it’s very important to have incoming revenue and outgoing expenses tracked to keep the cash position of the business properly monitored.
The main differences
The biggest difference between cash basis accounting and accrual basis accounting is when the business transactions are recorded. Other variances include:
- Cash basis accounting is easier as line items aren’t documented until cash exchanges hands
- Accrual accounting recognises revenue and expenses as they happen
- Tracking the cash flow of a company is simpler with cash basis accounting
- Accrual accounting gives a more accurate picture of the profitability of the business
- Cash basis accounting is ideal for start-ups allowing management to focus on planning
- Accrual methods are commonly used by publicly-trading companies as it smooths out earnings over time
Need a small business accountant in London?
Reputable outsourced accounting services will provide you with an experienced accountant in London with expertise in both cash basis and accrual basis accounting. You’ll be able to discuss the needs of your business and find exactly the right solutions for you. Policies, procedures, and systems will be implemented to ensure that accurate financial and management reports are produced. You’ll get all the help and support you need.