Accrual Basis vs Cash Basis Accounting
When you start a business, you will need to decide whether you will record your books as accrual basis or cash basis.
When you use cash basis accounting, your sales and expenses are recorded on the date that cash has actually exchanged hands. The benefit to this is that it gives you a very clear picture of how much cash is in your bank account, but the disadvantage is that it does not give a very clear picture of the company’s actual sales and profits.
For example, Larry the Lawnmower completes a $500 job in early February but it takes over a month for him to chase up the payment from his customer. He ends up receiving the payment in March, so the $500 is recorded as revenue in March instead of February.
When you use accrual basis accounting, your sales and expenses are recorded when they occur even if they are not paid for yet. This means your company will have accounts payable (money owed to suppliers) and accounts receivable (money owed by customers) which means that accrual basis accounting shows a more accurate picture of your company’s health.
If Larry the Lawnmower was using accrual basis accounting in the above example, he would instead record the $500 revenue in February when the job was completed.
I recommend accrual basis accounting for most businesses as it is the most commonly used and it smooths out the earnings and expenses of the company over time.