Not sure what method you should use to manage your books, or which one is best suited to your business? Here’s a quick guide to help you understand cash and accrual accounting, and the pros and cons of each method.
Cash accounting tracks the actual money coming in and out of your business.
In cash accounting, if you get an invoice for something, you don’t record the cost in your books until you’ve paid the invoice. Similarly, when you send an invoice to a customer, you don’t record the sale in your books until you receive the money from the customer.
For example, if you send an invoice on Tuesday, and don’t receive the payment in your account until Thursday, you record the income against Thursday’s date in your books.
If you use accrual accounting, you record expenses and sales when they take place, instead of when cash changes hands.
For example, if you’re a builder and have sent an invoice for a project you’ve completed, you record the sale in your books even though you haven’t received payment yet.
This way of accounting shows the amounts you owe to people and the amounts owing to you.
Pros and cons
Cash accounting is:
- a simple system that keeps track of your business cash flow
- generally suited to smaller businesses that mostly handle transactions in cash, for example a hairdresser’s or a grocery store
- gives you a picture of how much money you have in your till and in your bank accounts.
- It doesn’t capture money that is owed to you or money you owe to others.
Accrual accounting is:
- more complicated than cash accounting
- better suited to businesses that don’t get paid straight away (for example, architects often provide services that they invoice at a later date)
- a system that tracks your true financial position as it captures money that is owed to you and money you owe others
- helpful if you’re dealing with lots of contracts or large amounts of money.
Accrual accounting is more complicated than cash accounting so you’ll need an in-depth understanding of bookkeeping methods or a professional to help you out.
Choosing a method
To work out which method best suits your business, think about:
- the size of your business
- how complicated your business transactions and processes are
- whether you have the resources to manage accrual accounting.
If you aren’t sure, it’s a good idea to talk to a business or accounting professional.
Managing the finances of your business
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