Cash and Accrual are terms that apply to how a business notes their revenue and expenses. It is both a simple concept and quite involved. I will keep the answer simple here and encourage you to join Small Business Bookkeeping on Facebook for on-going discussion if you want to know more.
In cash basis, revenue is recorded when it is in hand and expenses are recorded when they are paid or charged to your credit card. That’s pretty straightforward. All of us as individuals can be said to operate on a “cash basis”.
Accrual records these things differently. Revenue is recorded when it is earned. Some businesses perform a service but don’t get paid right away. If they are accrual, that is shown as income right away, even if they haven’t been paid. Likewise, their expenses are recorded when they are incurred. If they receive a bill but don’t pay it for 30 days, under accrual, that expense is shown on the accounting and bookkeeping records at the date incurred.
Why Does It Matter?
That’s the big question, and one which small and micro-business owners particularly may not understand, if they operate on an immediate system of paying bills and receiving income. If that describes you, then you are solidly a cash basis business.
Sometimes in actual practice, we have a little bit of both going on. We might actually receive payments from our clients at the time of service, but we might actually have payment terms with some of our vendors. Etc.
Thus, the more important aspect of cash vs. accrual is how you REPORT your income, at tax-time or any time you have to provide financial statements (getting a loan, etc.).
It affects the valuation of a business, as well as income/expense levels in a reporting period. Think about it like this. You have a bill that comes in December 11 but isn’t due until January 10. You pay it on January 6. Under cash, that expense shows in the new year. Under accrual, that expense shows under the old year.