Cash Accounting vs Accrual Accounting
When acting as a part time Finance Director or interim Finance Director we are often asked why there is nothing in the bank account, but the Profit and Loss Account shows profits. To understand your accounts, you need to know which basis of accounting you are using, cash accounting or accrual accounting. You also need to ensure that the method used is appropriate for your business so that you have a sound basis for decision making.
With cash accounting income and costs are recorded when the cash related to the transaction is actually received or paid. However, under accrual accounting income and costs are recorded when the transaction occurs but before money is received or paid. Accrual accounting will therefore record debtors for unpaid sales and creditors for unpaid costs. The accounting basis used should be the one that more closely reflects reality and the nature of the business.
A comparison of the two methods is set out below.
| Cash accounting | Accrual Accounting |
| Simply and easy to manage, but only records transactions when cash is received or paid | More effort required but records revenue when earned and costs when incurred, even if these are unpaid |
| More appropriate for small businesses | Large companies should use accrual accounting, not cash accounting |
| Gives a real-time cash view | Provides a more accurate and complete financial picture |
| Not ideal for businesses with credit sales | Provides unpaid debtors to facilitate credit control |
Many business owners celebrate revenue, even if it hasn’t been paid yet, whilst overlooking costs that haven’t been paid.
At growing companies, if cash accounting is used the disconnect between perceived financial health and actual cash flow can lead to cash shortfalls at crucial times. Without the record of debtors and creditors that you get with accrual accounting it is very difficult to carry out cash flow forecasting which is vital to highlight deficits in cash in the near future.
Make your choice of accounting method strategic, not convenient.
We would normally recommend accrual accounting unless the business is very small and continues to be small.
If you need a part time Finance Director or interim Finance Director contact us today at [email protected] or call us on 01628-623444.