Cash vs Accrual Accounting

Is your accounting method the reason you have a positive (or negative) cash flow?!

There are two accounting methods for businesses: cash and accrual. While cash accounting is much simpler and more accurate in representing real-time cash flow, accrual accounting includes unearned revenue and prepaid expenses and provides a more accurate picture of a business’s profitability.

The main difference between the two accounting methods is TIMING. Here’s how the two methods work:

• Cash Accounting: revenue and expenses are recorded when cash is received or spent, regardless of whether goods or services have been provided.

• Accrual Accounting: revenue is recorded after goods or services have been “earned” or delivered, and expenses are recorded once billed.

The accounting method you use affects how you interpret your cash flow and liquidity. For example, a customer orders and pays 2,000 Euros in January for clothing items. However, the item will be delivered in February.

• Cash Accounting: The 2,000 Euros are recorded as income in January because that's when the money is received.

• Accrual Accounting: The 2,000 Euros is recorded as income in February because that’s when the customer receives the items.

On the other hand, if your business receives a bill for 1,500 Euros in January but pays it in February, the accounting method used determines when it is recorded.

• Cash Accounting: The 1,500 Euros is recorded as an expense in February because that’s when it’s paid.

• Accrual Accounting: The 1,500 Euros is recorded as an expense in January because that’s when the bill is received.

At the end of the month, this results in:

• Under cash accounting, your cash flow in January is +2,000 Euros (positive), and in February, it's -1,500 Euros (negative).

• With accrual accounting, your cash flow in January is -1,500 Euros (negative), and in February, it is +2,000 Euros (positive).

Send us any questions about the two accounting methods, and we’ll try to clarify them for you!