In this article, we’re going to be taking a look at the difference between cash and accrual accounting. We’ll cover the pros and cons of the two methods and by the end of this article, you should have a clearer view of whether cash or accrual accounting best suits the needs of your business.
The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognised.
With cash basis accounting, a more immediate recognition of revenue and expenses is recorded and income is recognised only when money changes hands. So, for example, if you follow the cash accounting method and invoice a client for $500 in February but they don’t pay you until June, the revenue is recorded under June, not February.
With accrual basis accounting the focus is on anticipated revenue and expenses. So income is recognised as soon as an invoice is raised. And when a bill comes in, it’s recognised as an expense even if payment won’t be made straight away. So, for example, if you issue an invoice for $200 in May but receive the money in October, you make a record of that $200 receivable in May.
We have helped hundreds of Australian businesses with their financial systems and accounting software setup. If you’re not sure which accounting method to adopt in your business, or are considering changing, give us a call on 1300 728 875 or send us a message to discuss your needs.
For more information on Australian accounting methods for business, visit the Australian Taxation Office website.
Cash vs Accrual Accounting Pros and Cons
Advantages of Cash Accounting
- It’s a simple system that keeps track of your business cash flow and there is no need to keep track of things like accounts receivable and accounts payable.
- Shows how much money you have on hand.
- Suits smaller businesses if you mostly have cash transactions (for example, a hairdresser or grocery store).
- It’s an easier option for calculating GST, though not all businesses are allowed to use it.
- Income tax expense is easier to manage as you only have to pay taxes on revenue received within a particular month.
Disadvantages of Cash Accounting
- It’s not accurate as it could show you as profitable when you just haven’t paid your bills.
- It’s difficult to see a complete picture of your business’s financial status without a record of all accounts payable and receivables.
- It’s not useful when making long-term financial decisions as you only have a day-to-day view of finances without a true understanding of all your debts/profits.
- It doesn’t show money that is owed to you or money you owe to others.
Advantages of Accrual Accounting
- It suits businesses that don’t get paid straight away (for example, architects who provide a service then invoice for it later).
- Tracks your true financial position by showing money owed to you and money you owe others.
- It’s helpful if you deal with lots of contracts or large amounts of money.
- It provides a more realistic, long-term picture of your finances. With a more detailed report of your cashflow, the accrual method enables you to make more accurate projections for your revenue stream and put contingencies in place for dry spells.
- There is no need to change accounting methods when your business grows.
- Complies with GAAP (Generally Accepted Accounting Principles).
Disadvantages of Accrual Accounting
- It’s more complicated than cash accounting so an in-depth understanding of bookkeeping methods is needed.
- It’s time-consuming work. If you’re the head of your company and you’re handling bookkeeping too, keeping up with accrual accounting might prove to be too much work.
- The accrual method can give you a false sense of financial security as you’re recording invoices that haven’t been paid yet.
- It puts you at risk of paying taxes on income before cash is received.
Which Accounting Method is Best for Your Business?
As you can see from the above, both cash basis and accrual accounting have their advantages and disadvantages. Cash accounting can help freelancers and small businesses manage tight cashflows and reduce the stress of tax time. However, it’s not as useful as accrual accounting for financial planning, especially for larger businesses.
Although cash accounting is simpler and easier to adopt, modern accounting software can help alleviate the complexity of accrual accounting. For growing businesses, it could be a smart move to adopt the accrual method.
Still not sure which accounting method is best for your business? Give us a call on 1300 728 875 or send us a message for an obligation-free consultation.