This guide to help you work out the difference between cash and accrual accounting.
The difference between cash basis and accrual basis accounting comes down to timing.
When do you record revenue or expenses?
If you do it when you pay or receive money, it’s cash basis accounting.
If you do it when you get a bill or raise an invoice, it’s accrual basis accounting.
Accrual accounting is a far more powerful tool for managing a business, but cash accounting has its uses.
What is cash basis accounting?
Businesses that use cash basis accounting recognise income and expenses only when money changes hands.
They don’t count sent invoices as income, or bills as expenses – until they’ve been settled.
Despite the name, cash basis accounting has nothing to do with the form of payment you receive. You can be paid electronically and still do cash accounting.
Benefits of cash accounting
It’s simple and shows how much money you have on hand.
It’s an easier option for calculating GST, though not all businesses are allowed to use it – check out https://www.ato.gov.au/business/income-and-deductions-for-business/assessable-income/accounting-meth
Downsides of cash accounting
It’s not accurate – it could show you as profitable just because you haven’t paid your bills.
It doesn’t help when you’re making management decisions, as you only have a day-to-day view of finances.
What is accrual basis accounting?
Businesses that use accrual accounting recognise income as soon as they raise an invoice for a customer. And when a bill comes in, it’s recognised as an expense even if payment won’t be made for another 30 days.
Benefits of accrual accounting
You have a much more accurate picture of business performance and finances.
You can make financial decisions with far more confidence.
It can sometimes be easier to pitch for long-term finance.
Downsides of accrual accounting
It’s more work because you have to watch invoices, not just your bank account.
You may have to pay tax on income before the customer has actually paid you – the customer reneges on the invoice, you can claim the tax back on your next return.
Choosing a method
To work out which method best suits your business, think about:
1. the size of your business.
2. how complicated your business transactions and processes are.
3. whether you have the resources to manage accrual accounting.
4. whether using an electronic system will make a difference.
Example of cash basis accounting
If you invoice a client for $2,000 on March 20 and receive payment on April 18, you would record the income as received for the month of April, since that’s when you actually had the money in hand.
So the breakdown looks like this:
The invoice is sent for $1,000 in March
You do nothing in March
You receive payment in April
You record the income in April
Example of accrual accounting
Using the example from above, if a small business bills a client $2,000 on March 20, you would record that $2,000 as income in March’s bookkeeping—even if the funds didn’t clear your account until April 18.
The invoice is sent for $2,000 in March.
You record revenue in March.
The same holds true for accrued expenses.
In this case, example - if your small business buys supplies on a credit card in June, but doesn’t actually pay that bill until July, you would still record that as a June expense.
Let’s break this down:
You bought supplies in June.
You record the expense in June.
Information sourced from Xero & ATO.