Cash or Accrual can sometimes be confusing subjects for those new to bookkeeping. The terms describe two methods of accounting that are used. The cash method records transactions when money changes hands. The accrual method records them when a bill is received or an invoice is created, whether or not either has been paid.
In cash accounting you do not record sales, costs or expenses until money is received or spent. You don’t need to maintain a full General Ledger for this kind of accounting. It is best used for businesses that need a simple bookkeeping system to record what they earn and what they spend, such as a service business.
For example, I use the cash method of accounting for my bookkeeping business because I pay my costs and expenses at the time I receive goods or services. Also, I normally get paid within a day or two of invoicing my customers, so I don’t carry much accounts receivable. The smaller and less complicated your business, the more likely it is you will use this method.
Accrual accounting on the other hand is much more detailed and requires more time and effort to maintain. It is even required for some businesses. With this kind of accounting a business records sales when it creates an invoice for a customer, not when the customer pays the invoice. The business records its expenses and costs when it is billed by vendors, not when it pays the bill.
A manufacturing or construction company will be more likely to use the accrual method of accounting if they do progress billing with their customers. In this case they will have payment terms for their customers such as payment due in 10 days or 30 days. This means the company may need to purchase materials on account and pay for them when they receive money from their customers.
When deciding whether to use cash or accrual, consider the size of the business and how quick of a turnover a business has with its sales and inventory. For businesses with a greater amount of activity, accrual accounting is best because it provides a much more accurate picture of how the business is doing. If you are unsure, it would be best to consult your tax accountant who can help you determine what is best for financial reporting, bookkeeping and tax purposes.