Have you heard your accountant or bookkeeper toss the phrases accrual or cash basis? What does it actually mean? How does it apply to you and your business? It’s important to know the difference because it changes how you run your business. Let’s get into the differences.
Let’s say you make an invoice for $1,000 to a client on Jan 31. The payment doesn’t come in until Feb 2. Is that income counted for January or February? In the accrual method, it’s counted for on the day the invoice was made in January. Bills are recorded once you receive the bill, not when the payment leaves the bank. With this method, you can show a more accurate picture of how your business is actually doing on a monthly basis. Income will match better with the expenses.
Cash based accounting will record the payment on the day that cash reaches the bank. In the above example, this would mean the income isn’t counted until February when the deposit comes in. Expenses are recorded on the day they’re paid. This method is simpler to use and less time consuming. You’re able to get a good picture of what your cash flow looks like, no matter how many invoices or bills you have out there.
Most small businesses run their business using the cash based method. It’s easier to understand how much cash you actually have (and cash is king). This means you’re less likely to spend money you don’t have yet. This is especially important for tradesmen who might not get paid until the work is done. Always ask your accountant whether cash or accrual is best for your specific business. And if you don’t have an accountant, consider reaching out to Aladdin Bookkeeping: Bookkeeping for Contractors so you don’t feel left out of the cool kids club.
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