Cash or Accrual – Which Accounting Method to Use
Image from Educba.com
If you run a business, you must choose the cash or accrual accounting method when you file your taxes. Both have pros and cons, so it’s important to understand how they work, and which would benefit you more.
What is the Cash Accounting Method?
With the cash method, you record transactions when they take place. In other words, when a client pays an invoice, you record the transaction and when you pay an invoice you record the transaction.
With this method, you don’t record transactions until they take place. For example, if you billed a client in 2021, but they didn’t pay the bill until 2022, you wouldn’t record receipt of the funds until 2022.
What is the Accrual Accounting Method?
With the accrual method, you do things differently. Instead of waiting until you receive the funds to record receipt, you record it when you create the invoice. The same is true of expenses. You record them as soon as you incur them even if you don’t pay them until next month or next year.
An Example of Each Method
Let’s look at how these methods differ.
John owns a business and had the following transactions:
- A client paid a $1,000 bill from a job he did last month
- Another client paid him $2,000 for a job he did this month
- He billed a client $2,000 for a job he did this month
- He paid $1,000 in expenses he incurred this month
- He paid $500 in expenses he incurred last month
Here’s how the cash method would look:
John would have $3,000 in income and $1,500 in expenses for the month. This leaves him with $1,500 in profit for the month.
Here’s how the accrual method would look:
John would have $2,000 in income and $3,000 in expenses. This leaves him with $1,000 in profit for the month.
Which is better? It depends on your situation. While most of my clients use the cash method because they don’t have to pay taxes until they receive the funds, some prefer the accrual method for other reasons.
We’d be happy to sit down and discuss your situation to help you decide. Contact us today to learn more!