When you set up your books you choose between two accounting methods. They differ in one thing only: when income and expenses are recorded.
The difference in one sentence
With cash accounting, income counts when you receive the money and expenses count when you pay them. With accrual accounting, income counts when you issue the invoice and expenses count when you receive the bill, whether or not any money has moved.
An example
You finish a job in March, invoice 2,000, and the customer pays in April. On a cash basis the 2,000 is April income. On an accrual basis it is March income, and you also have 2,000 owed to you at the end of March. Now say you receive a supplier bill for 500 in March and pay it in May. On a cash basis the cost lands in May; on an accrual basis it lands in March.
| Cash basis | Accrual basis | |
|---|---|---|
| Income recorded | When money is received | When the invoice is issued |
| Expenses recorded | When money is paid | When the bill is received |
| Shows money owed to and by you | No | Yes |
| Simplicity | Very simple | Needs invoices and bills to be entered |
| Matches income to the costs of earning it | Poorly | Well |
Why accrual usually gives a truer picture
Because it matches income with the costs of earning it in the same period, accrual accounting shows how profitable a month really was. Cash accounting can make a good month look bad because a big customer paid late, or a bad month look good because you delayed paying suppliers.
Why some businesses choose cash
Cash accounting is easier to understand and mirrors your bank account. Many sole traders and very small businesses use it, and in some countries tax rules let small businesses account for tax on a cash basis. It is less suitable once you offer credit terms or hold stock.
Which should you choose?
- Check the rules. Your country may require accrual accounting above a certain size, or allow a simpler method below it.
- Ask your accountant. The choice affects your tax and how you report to banks and investors.
- Think about your customers. If you give 30-day terms or keep stock, accrual accounting will serve you better.
- Be consistent. Changing method later is possible but needs care, so pick one you can live with.
In AvrioBooks you choose accrual or cash for each business when you create it. See Create your business for the steps, and note that you can compare how your results look under each by speaking to your accountant before you commit.
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