Accrual vs Cash Basis

One of the biggest and most overwhelming aspects that new business owners usually have with their books is understanding the difference between Accrual and Cash Basis when running their reports.

And depending on how you use your accounting software, it can make a huge difference.

Though I would like to stipulate that you should be pulling your reports based on which method your taxes get filed under and your very first tax preparer should have reviewed your options with you to figure out which is best for your business. This is not something that can be changed frequently and if you choose to switch accounting methods, please consult your tax preparer and ensure the appropriate Form 3115 gets filed.

I am a fierce advocate of having strong and healthy communication with your bookkeeper/accountant. Ask questions until you understand. Because ultimately, this is your responsibility as a business owner.

To find which method your business files under, look at your last tax return. Below is a list of common small business filings and where to locate which applies to your business:

Single Member LLC – Schedule C, page 1, Line F
Partnership – Form 1065, page 1, Line H
SCorp – Form 1120-S, page 2, Line 1
CCorp – Form 1120, page 4, Line 1

Now that you are equipped with your business’s accounting method, let us dig in!

Accrual Method

The accrual method is generally used for companies who fully embrace the invoice/bill section of their accounting software.

Whenever you receive a bill, you enter that bill into your system and then at a later date, you cut the checks to pay your vendors.

So let’s say we received a $500 bill from your accountant on June 14th. You would enter that under your ‘Bill’ feature. You are essentially entering everything that the invoice gives you; date, terms and any splits that are applicable (maybe you have different line items for payroll fees vs bookkeeping/taxes).

The date that the invoice was produced is when it will show up in your reports. This is why it is so extremely important to enter your invoice exactly as it is. Meaning, if you don’t pay that $500 bill until August, it will still show up on your reports in June.

The same is applied to invoices. If you invoice in May but don’t get paid until July, the invoice is recognized in May.

Cash Method

While it is still a good idea to track your bills with the ‘Bill’ feature in your books, it isn’t as important for proper reporting with cash method.

When the bill is incurred won’t appear on your reports, but when you pay it will. So as soon as you cut that check or pay that expense, that is when it will show on your books.

The same applies to invoices. It doesn’t matter when you charge your clients, it is applied to your books when you receive your money.

Wrapping it all up

To summarize, with the accrual method your financials will reflect when the company invoices and gets billed, whereas cash method is when the company physically got paid and paid a bill.

The important part of this is knowing when your income/revenue and expenses are expressed on your reports and how/why there is a difference.

It is best to always pull the reports that your taxes are based on because that is essentially what all your businesses decisions should be based on.