Why do you need to understand accounting methods to apply to your business?
When you’re running a business, one of the most important financial decisions you’ll make is how to track your income and expenses. The two primary accounting methods—cash and accrual—each have their pros and cons. Choosing the right one can significantly impact how you manage your cash flow, pay taxes, and understand your overall financial health.
Let’s explore the key differences between cash and accrual accounting, with practical examples to help you decide which is the right fit for your business.
What Is Cash Accounting?
Cash accounting records revenue and expenses only when money changes hands.
Income is recorded when you receive payment.
Expenses are recorded when you actually pay them.
Simple and easy to manage.
Common for freelancers, sole proprietors, and small service businesses.
Example:
Let’s say you’re a jewelry designer. You sell a custom necklace on June 15 and receive payment on July 5.
Under cash accounting, income is recorded on July 5—the day the money is deposited into your account.
You buy packaging supplies on July 10 and pay immediately. That expense is recorded on July 10. If you have the option to postpone payment within 30 days, and the expense is recorded on the day you make payment within the allowed timeframe.
What Is Accrual Accounting?
Accrual accounting records revenue and expenses when they are earned or incurred, regardless of when money is exchanged.
Income is recorded when the sale is made (even if not yet paid).
Expenses are recorded when incurred (even if not yet paid).
Provides a more accurate picture of your business’s financial health.
Required by GAAP (Generally Accepted Accounting Principles) and for companies with over $25M in annual revenue.
Example:
Using the same jewelry business:
You sell that necklace on June 15, and the client promises to pay by July 5.
Under accrual accounting, the income is recorded on June 15, when the sale occurred—even though you haven’t been paid yet.
You receive an invoice for a purchase made on July 1, with a due date of July 20. The expense is recorded on July 1, even if you pay it on July 20.
Which Method Is Right for You?
Choose Cash Accounting if:
- You’re a solo service provider or freelancer.
- You want simplicity.
- You don’t carry inventory.
- You want to track real-time cash flow.
Choose Accrual Accounting if:
- You send invoices or have accounts receivable/payable.
- You hold inventory.
- You need to see your true profitability in a given period.
- You’re planning to apply for funding or scale your business.
There’s no one-size-fits-all answer—your choice depends on your business model, goals, and how you prefer to manage finances. Many small businesses begin with cash accounting and transition to accrual accounting as they grow.
John Doe contributed to this article.
