Sooner or later every entrepreneur runs into the terms “accrual method” and “cash method” — and struggles to decide which one applies to them. Let us work through the differences, the specifics and where each one belongs. A few minutes is enough to put this question in order and make the right call.
How the two methods differ
A company’s income and expenses can be recorded using one of two methods: accrual or cash. The main difference is when income and expenses are recognised.
In short, the cash method recognises income and expenses sooner in terms of actual money movement, while the accrual method works with income and expenses as they are earned or incurred.
Accrual method: income and expenses belong to the period in which they arise, on the first-event rule — regardless of when the money actually arrives or leaves.
Cash method: income and expenses exist only at the moment money is actually received into, or paid out of, the account.
Let us look at each one separately.
The accrual method
One advantage of the accrual method is that it carries receivables and payables. As a result it gives a more accurate picture of profitability, particularly over the longer term. The accrual method is what produces the P&L, the profit and loss statement.
At the same time it has a significant drawback: it does not track cash flow. A company can look profitable over the long run while running short of money in the short term, and the accrual method will not warn you.
Another downside is that it is harder to implement, because you have to account for unearned revenue and prepaid expenses.
The cash method
The cash method recognises income or expenses only when money is actually received or paid. Revenue appears in the report only once the money has arrived; an expense is registered only once it has been paid. This is largely how personal finances work.
Simplicity is its main advantage — it deals only with money received or paid out, which is why cash flow is easier to control this way. The cash method is what produces the cash flow statement.
It has drawbacks too. It can overstate the health of a company that holds a lot of cash while also carrying large payables that exceed both the cash in the books and the current income stream.
Examples
Suppose your business sells household appliances. If a sale amounts to UAH 40,000, under the cash method that amount does not appear in the books until the customer has paid. Under the accrual method the UAH 40,000 is recorded as income immediately after the sale, even if the money arrives later. The same logic applies to expenses.
If you receive a utility bill for UAH 9,000, under the cash method the amount stays out of the books until the bill is paid. Under the accrual method those UAH 9,000 are recorded as an expense on the day the bill arrives.
Which method should you choose?
Each has its strengths and weaknesses. The cash method is simpler and more intuitive. The accrual method shows real profit and makes it much easier to analyse how efficient each line of business is.
To see the whole picture, an owner needs to look at finances both in real time and in planning terms. That means producing both reports: cash flow by the cash method and P&L by the accrual method. Only then can you genuinely control the business and plan its growth.
Recording income and expenses in the QUINCEFIN cloud service is straightforward: enter your operations from anywhere, generate reports in two clicks and get the time back.