Cash Basis And Accrual Accounting

Keeping your financial records in order requires professional expertise, but there’s nothing better than also knowing the basics of accounting so you can truly understand where you are situated as a business. If you are not an expert on this, it doesn’t matter as long as you have a reliable team that can handle your requirements effectively. But to be able to understand what they make of your records is always a plus. Otherwise, you leave a lot of room for error which can get you in trouble with the law. To avoid this, you can begin by developing an appreciation of the two basic accounting methods being used universally – cash basis and accrual.

Cash basis accounting is when you list down your expenses in your financial accounts the moment you have actually given out the cash and list down your profit when you have actually received payment and credited it in your bank account. For example, if you began a software development project in November 2010 but got paid for it in March 2011, cash basis accounting will have you entering this revenue in your 2011 report. This is a simple way of handling financial records and this is also used by small businessmen. The main advantage of this method is that it allows the businessman to keep track of how much cash is actually available because expenses and profits are recorded only when they have actually exited and entered the bank account.

In contrast, accrual accounting is when you list down your expenses before you have given the cash and your profit before you have received the cash. For example, if you sell books wholesale, you list down your revenue on your accounting books for the year when the transaction was completed even when you have yet to receive payment. In the same way, you list down your expenses for shipment and other cash outlays even when the money has not exited the business’ bank account yet. This is usually how corporations’ financial reports are handled. The problem with this method is that cash available does not necessarily tally with what the records are saying because here, you already deduct expenses and add revenues before they even materialize in the bank account.

In terms of taxes, these two methods will also create a difference. Those who use cash accounting can ask that payments be put on hold till the following year so their current year income and income tax can be reduced. It works the other way around for those who use accrual accounting where the businessman pays taxes based on what is reflected on his accounting records, whether cash has been credited to the bank account as payment or deducted as an expense.