Cash Vs. Accrual Accounting: What’s The Difference?

Tuesday, 22 Aug 2023

Bookkeeping, in its most basic form, involves recording all business transactions correctly. Professionally qualified bookkeepers are hired by organisations in Melbourne to ensure they have up-to-date books for filing accurate taxes, paying salaries on time and raising invoices. They employ different methods to manage these records.

The two ways of accounting utilised by professionals are cash basis accounting and accrual accounting. Although accrual is more prevalent than cash accounting, many entrepreneurs rely on the latter for financial management. Let us understand the basic differences between cash and accrual accounting and how it affects the business. Entrepreneurs can utilise this information to find the most suitable method for their organisation.

Main Difference between Cash and Accrual Accounting

The key difference between cash and accrual accounting is the time of recording the transaction. It implies that cash basis accounting records an income or expense when the cash is received or paid. Conversely, the accrual basis involves recording the income or expense when the business receives a bill or sends an invoice to the customer.  

What Is Cash Basis Accounting?

Cash basis accounting recognises revenue or expense when actual cash is exchanged, such as paying the supplier for the stock or receiving money from the client after the delivery of products. The transaction can take place online or through the exchange of cash.

It is a simple method of accounting that sole proprietors and small businesses use. It is also beneficial for businesses that do not have to deal with inventory, such as a web designing company or a travel agency. Cash basis accounting helps bookkeepers Melbourne easily track the cash flow.   

What Is Accrual Basis Accounting?

Accrual accounting recognises the income or expense when finalised instead of waiting for the exchange of cash. Thus, the bookkeepers will record the incoming when the client places the order rather than the money coming into the business.

It is a highly preferred way of accounting because it provides a clear picture of the income and expenses of the entity in a given period. It helps to understand the financial stability of the entity but does not provide information about the cash flow.

Cash vs. Accrual Accounting: What’s the Difference?

Let us compare both accounting methods on different parameters to understand their disparity.      

Revenue and Expense Recognition Timing

In cash-basis accounting, Melbourne bookkeepers mention the financial transaction in the ledger when the cash is received or paid. Conversely, in accrual accounting, the transaction is mentioned when the invoice is raised or the bill is received.    

Tax Liability of the Business

In cash accounting, taxes are not paid until the incomings are received. In accrual accounting, taxes are paid when the income is recorded as per the bookkeeping standards. An advantage of using the latter system is that the business can leverage the depreciation of assets in the long run.

Cash On Hand

With cash-basis accounting, bookkeepers in Melbourne can easily check the cash available on hand because it counts the incomings and outgoings. However, with accrual accounting, you cannot tell the current amount in the business. It provides a glimpse of future revenue and expenses by providing a long-term picture. It is also more informative because it informs about the receivables and payables.  

Financial Statement Audits

Cash-basis accounting does not allow auditing of the financial statements, whereas accrual allows it when the statements are generated in line with the accrual-basis accounting.   

Level of Precision

Bookkeepers in Melbourne use the accrual basis of accounting because it is more accurate recordkeeping than the cash basis. In cash accounting, it is not clear if the business is financially healthy. For example, a business may experience a downfall in income in the first quarter because of unpaid invoices. However, when they get paid in the next quarter, it will show a sudden rise in income.

This information is inaccurate because this amount was supposed to come in the last quarter. So, accrual accounting is more precise because it records transactions when they are earned. The entrepreneur can make better business decisions based on this accounting that helps to determine the business performance.  

Cash vs. Accrual Accounting: Which Is Better?

Accrual accounting is more complex and requires a lot of time and effort. It is used by medium and large-sized businesses that do not get payments from clients right away. It helps to identify the amount the business has to pay and the amount that others have to pay to the business. 

Cash-basis accounting is simple and can be managed by the owner-operator easily without hiring a professional bookkeeping company in Melbourne. Since tax is paid only on the cash received, it helps to save money and improve cash flow. Thus, it is suitable for small businesses that use cash transactions.

Bookkeepers decide between the two methods based on the size of the business, the type of transactions taking place in the organisation and the infrastructure of the entity.

Wrapping Up

Business owners should pay attention to the accounting method their Melbourne bookkeepers use. It will help them understand whether they are following the right method or need to change their recordkeeping systems.      

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