Proper recording of incoming and outgoing values is vital. Not just for financial reasons, but also to evaluate its success. To help you control your company’s finances , we’ve put together a guide on cash basis and accrual basis. Understand what they are, the pros and cons of each and how they work in practice below.
What is cash basis?
The cash basis is the model that accounts for the inflow and outflow of money from a monetary transaction . That is, you only consider a sale or an expense when you pay or receive it. Even if a contract was performed before, it is not considered by itself.
In practice, imagine that your company makes a contract with a supplier for payment in 2 installments. The cash basis will only consider financial transactions. When you pay the first installment, an exit will be registered. In the second installment, another output. Even if you know that you will have to pay the amount the following month, it is not considered on the cash basis until you leave the account .
What are the advantages and disadvantages of the cash basis?
The advantage of the cash basis is that it is simple . It indicates the amount in the cashier and the exact day the money enters and leaves the account. Therefore, it is considered an easy-to-keep cash flow record.
The downside of the cash basis is that it can give a false sense of the financial situation of the business. By ignoring future payments, the cash basis can be positive one month and “suddenly” turn negative the next.
What is an accrual basis?
The accrual basis is the financial control system that considers the act of purchase or sale . In other words, the moment you make a contract or a customer makes a purchase, the accrual basis registers.
The accrual basis operates independently of cash inflows or outflows. Suppose that on the same day you make a cash sale and sign a contract with a supplier to pay on receipt. Both transactions are included on an accrual basis, even though one affected the account at the time and the other did not.
How does the accrual basis differ from the cash basis?
The advantage of the accrual basis is that it facilitates financial control planning. You can know when you made a certain purchase and how it is reflected in your cash flow. The same goes for sales.
The downside is that the accrual basis can “get lost” in the present . A month with a lot of contracts and investments can suggest that you are in debt . When in reality they are contracts with different monetary transaction dates and that do not represent a bad moment for the company.
Differences and similarities between the two accounting regimes
Cash basis and accrual basis generally happen at different times. When issuing a bank slip, for example, the value is counted on an accrual basis at the time. But it will only enter the cash basis when the amount changes the account.
If the purchase/sale decision and the payment occur on the same day, then the fact will be recorded on a cash basis and on an accrual basis simultaneously. Therefore, it is ideal for your cash flow to use both a cash basis and an accrual basis .
Small companies can maintain sound financial management with just the cash basis. But when the business grows and the bills get complicated, then the accrual basis is necessary.