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/2 min read

Cash v. Accrual Accounting

Cash vs Accrual

FeatureWhen revenue is recognized
Cash AccountingWhen cash actually changes hands — simple, used by small businesses.
Accrual AccountingWhen earned/incurred regardless of cash timing — required by GAAP for most companies.
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Explore the fundamental differences between cash-based and accrual accounting methods, including their advantages and disadvantages, while being guided by the most commonly used method in the business industry today.

Cash-based accounting is what we would intuitively think of: revenues are generated when we collect money, and expenses are incurred when we pay for them

Accrual accounting books revenues when services or goods are delivered (not when they are paid for), and expenses when they are incurred (not when they are paid for)

For example, a company delivers a service but has not received payment yet, revenue would still be recorded. The money owed would be booked as accounts receivable as an asset on the company’s balance sheet.

On the flip side, if a company collects cash for a service it has yet to deliver (for example, an airline collects ticket fare three months prior to the travelers’ flight) the collected cash would not hit the company’s revenue (until the date of the customers’ flight). That is known as unearned, or deferred, revenue, which would show up as a liability on the company’s balance sheet because the company owes the service.

The accrual method is the most commonly used method, especially by publicly-traded companies as it smooths out earnings over time.

Cash-Based

Advantage: Simplicity—it only accounts for cash paid or received

Disadvantage: 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

Accrual

Advantage: 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

Disadvantage: More complicated to implement since it's necessary to account for items like unearned revenue and prepaid expenses

Video Transcript5 sections

1Full Video Transcript

2Cash-Based Accounting Fundamentals

Let's talk about cash versus accrual accounting. Cash-based accounting is what we would intuitively think of. Revenues are generated when we collect money, and expenses are incurred when we pay for them.

Accrual accounting books revenues when services or goods are delivered, not when they are paid for, and expenses when they are incurred, not when they are paid for. For example, a company delivers a service but has not received payment yet. Revenue would still be recorded, and the money owed would be booked as accounts receivable as an asset on the company's balance sheet.