What is the difference between accrual and cash basis accounting?

Accrual basis accounting records revenue when it is earned and expenses when they are incurred, whatever the date cash moves. Cash basis accounting records them only when money is actually received or paid.

How each one works

Under the accrual basis, an invoice for work done in December is December revenue, even if the customer pays in January. Receivables, payables, accruals and prepaid expenses all exist to make this work.

Under the cash basis, the same invoice is January revenue, because that is when the money arrived. It is simpler, but a month's profit then depends on when customers happened to pay.

Accounting frameworks such as US GAAP, IFRS and Canada's ASPE require the accrual basis. Many small businesses keep cash basis records for their own use. Whether a business may use the cash basis for tax depends on the country and the size and type of business, so check with an accountant or the tax authority.

Worked example

In December, a business finishes a $10,000 job and receives a $600 electricity bill. The customer pays on January 15 and the bill is paid on January 10.

Accrual: DecemberAccrual: JanuaryCash: DecemberCash: January
Revenue$10,000$0$0$10,000
Electricity$600$0$0$600
Profit$9,400$0$0$9,400

The total over the two months is the same, $9,400. Only the month it lands in changes.

Common mistakes

  • Mixing bases. Comparing a cash basis month with an accrual basis month creates variances that aren't real. Export every report on the same basis.
  • Forecasting cash from an accrual P&L. Accrual profit is not cash. Use the agings and bank balance for a cash forecast.
  • Switching part way through a year, which makes YoY and TTM comparisons meaningless.

Related terms

  • Month-end close: The month-end close is the set of steps an accounting team completes after each month ends to make sure the books for that month are complete and accurate, before locking the period.
  • Gross margin: Gross margin is revenue minus the cost of goods sold (COGS), shown as a percentage of revenue.
  • 13-week cash flow forecast: A 13-week cash flow forecast is a week-by-week projection of the cash coming in and going out of a business over the next quarter, starting from today's bank balance.

Further reading