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What is the Difference Between Cash and Accrual Accounting?

Are you starting to set up your business or looking for ways to streamline your accounting? 

TPI Group’s accounting services help you to run whatever size business you have, and ensure that you are providing the IRS with the correct information. Whether you’re doing your accounting yourself in an Excel sheet or working with your department using accounting software, there are two accounting methods that will facilitate record keeping:

  • Accrual accounting
  • Cash accounting

We’ll help you figure out which one is best for your situation.

What is Cash and Accrual Accounting?

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Cash-basis accounting is when financial transactions are recorded only when cash is received or withdrawn from your bank account. Income must be reported in the tax year it is received while expenses are deducted in the tax year in which the business pays them. 

With accrual-basis accounting, there’s no waiting for payments to be processed. Financial transactions, such as revenue and expenses, are recorded right away. Income must be reported in the tax year it is earned. Expenses are deducted in the tax year in which they are collected. 

Example of the Two Methods

Using cash-basis accounting, when you receive a monthly utility bill, you would record the expense in your books only when the money left your account. It is possible for a utility payment to be made at some point the following month, or even later.

By contrast, in accrual-accounting it would be necessary to record the expense as soon as the bill was received, regardless of any monetary exchange. 

Both accounting methods have their advantages and disadvantages, so if you have a small business that qualifies for cash-basis and accrual-basis accounting, it’s in your best interest to choose the right one. 

Special Note

The IRS doesn’t allow every business to use the cash method of accounting. They determined that cash-basis accounting cannot be used by businesses that do any of the following:

  • Manage inventory
  • Generate more than $5 million within a single year
  • Have public trading on the stock exchange

Businesses listed above must follow generally accepted accounting principles (GAAP), so investors and shareholders, for example, can see where their money is going and if the company is making a profit. Businesses of the type listed above may qualify for the hybrid method of accounting, which utilizes a combination of cash and accrual accounting. 

We encourage you to consult with our tax specialists to avoid problems.

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What are the Pros & Cons of Cash vs. Accrual Accounting?

Using the cash method or the accrual method could create trouble for your business if you choose the wrong one. To give you a better idea of which accounting method is best, here are the pros and cons of each:

Pros of Cash-Basis Accounting

Keeping track of transactions is simpler than accrual-basis accounting because you can record transactions when they are completed. 

Cons of Cash-Basis Accounting

A cash-basis accounting system doesn’t provide as accurate a picture of your business’ long-term health and trends or provide a real-time representation of its cash flow. A business can appear to be making a profit, but in reality, it has a high amount of accounts payable and is losing money.

Pros of Accrual Accounting

Unlike cash accounting, expenses are recorded immediately and allows businesses to track:

  • Earnings
  • Accounts receivable
  • Accounts payable

Business owners, creditors, stakeholders, and shareholders use this information to analyze and understand how the business is developing while knowing the overall profitability. 

Cons of Accrual Accounting

It’s up to you to keep track of the business’ cash flow at the same time as your accrual recordkeeping to ensure that you’re not spending money that your business doesn’t have. 

Whether you’re a small business owner, a corporation owner, or a high-income individual, it’s essential to use cash flow statements. They act as a log of the financial transactions of the business, displaying all the details of money that entered and exited. 

The accrual method of accounting requires the recording of any type of transaction before payment, whether the business must pay their supplier or a client must pay the business for services rendered. Businesses must remember to make or schedule payments.

Start Using the Right Accounting Method

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Still not sure if you should use cash-basis accounting or accrual-basis accounting? Our tax specialists can optimize your accounting, bookkeeping, and more, so all of your revenue and expenses are in shape for tax season. 

With TPI Group, we simplify financial processes and handle the stress that comes with dealing with taxes. Contact us today to set up a consultation.