Cash Vs Accruals accounting explained | Why does it matter?

The main difference between accrual and cash basis accounting lies in the timing of when revenue and expenses are recognized. The cash method is a more immediate recognition of revenue and expenses, while the accrual method focuses on anticipated revenue and expenses.

⏱️ Time Stamps:
0:00 - Introduction
0:38 - An example of a business using cash accounting
1:44 - What is cash accounting?
4:50 - What is accruals accounting?
7:38 - Pros and cons

★ Accrual Accounting Method
Revenue is accounted for when it is earned. Typically, revenue is recorded before any money changes hands. Unlike the cash method, the accrual method records revenue when a product or service is delivered to a customer with the expectation that money will be paid in the future. Expenses of goods and services are recorded despite no cash being paid out yet for those expenses.

☆ Cash Basis Accounting
Revenue is reported on the income statement only when cash is received. Expenses are only recorded when cash is paid out. The cash method is mostly used by small businesses and for personal finances.

The key advantage of the cash method is its simplicity—it only accounts for cash paid or received. Tracking the cash flow of a company is also easier with the cash method.

But a disadvantage of the cash method is that it might overstate the health of a company that is cash-rich but has large sums of accounts payables that far exceed the cash on the books and the company's current revenue stream. An investor might conclude the company is making a profit when, in reality, the company is losing money.

Meanwhile, the advantage of the accrual method is that it includes accounts receivables and payables and, as a result, is a more accurate picture of the profitability of a company, particularly in the long term. The reason for this is that the accrual method records all revenues when they are earned and all expenses when they are incurred.

For example, a company might have sales in the current quarter that wouldn't be recorded under the cash method because revenue isn't expected until the following quarter. An investor might conclude the company is unprofitable when, in reality, the company is doing well.

The disadvantage of the accrual method is that it doesn't track cash flow and, as a result, might not account for a company with a major cash shortage in the short term, despite looking profitable in the long term. Another disadvantage of the accrual method is that it can be more complicated to implement since it's necessary to account for items like unearned revenue and prepaid expenses.

We hope this video has helped you understand the differences between the accruals and cash accounting method and taken you one step closer to knowing your numbers.


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#CashAccounting #AccrualsMethod #Accounting

[tonydCFO]

The cash basis of accounting is almost the default. But it's not always the most beneficial for your business. Find out
⏱️ Time Stamps:
0:00 - Introduction
0:38 - An example of a business using cash accounting
1:44 - What is cash accounting?
4:50 - What is accruals accounting?
7:38 - Pros and cons

[juliehollandblubookkeeping]

Great explanation and love the video. I think the cashflow for paying vat on accruals method should have been addressed more, as most sole traders think this is the main reason to use cash basis.