Cash accounting vs accrual accounting: what is the difference?

Summary 

• Accrual accounting differs from cash-based accounting as it records income and expenses when they're earned or incurred rather than when revenues are recorded and received.

• The UK government revised and expanded the cash basis measure for smaller businesses in 2023, simplifying tax returns.

• Hybrid accounting combines cash and accrual accounting, making it helpful in tailoring accounting needs to each business.

• Unbiased can connect you with a qualified accountant for your business.

What is accrual accounting?

Accrual accounting records income and expenses when they're earned or incurred, regardless of when the money actually clears.

For example, if a company provides a service in January but is paid in February, the income still counts as January income.

The accrual accounting method gives a clearer picture of a business's financial health over time.

It's ideal for prominent companies with many transactions, like retail or manufacturing, as it shows a more accurate long-term view of finances and economic patterns.

What is cash accounting?

Cash accounting records income and expenses when funds actually change hands.

So, if a company is paid in full in February for work done in January, it counts as February income. 

When comparing cash and accrual accounting, this type of accounting is more straightforward.

This makes it ideal for smaller businesses with uncomplicated finances, such as freelancers and small shops, because it's easier to manage and understand.

Since cash accounting tracks cash flow directly, it's also handy for businesses with tight budgets as it gives a clear picture of available funds at any time.

However, it might provide a partial picture of long-term financial health.

What is the difference between cash and accrual accounting?

The most notable difference between cash and accrual accounting is when income and expenses are documented.

Cash accounting logs transactions when money physically changes hands, while accrual accounting records transactions when they're earned or incurred.

Here are some other differences between cash and accrual accounting to consider.

• Due to its straightforward nature, cash accounting is simpler and cheaper for UK small businesses. Still, it may not provide a comprehensive view of long-term financial health.

• Accrual accounting is more complex but offers a clearer picture of a business's financial status over time, making it more suitable for larger enterprises despite potentially higher implementation costs.

What are the pros and cons of cash accounting?

Cash accounting has its advantages and drawbacks. The pros and cons of cash accounting are outlined below.

Pros

• Cash accounting is easy to understand and apply.

• It is ideal for small businesses with simple finances.

• Cash accounting provides a real-time view of available funds, aiding in budgeting and cash flow management.

Cons

• Cash accounting's simplicity can be a limitation as it may not accurately reflect the company’s history of financial health or provide insight into long-term obligations.

• It doesn't comply with GAAP for larger businesses.

• Not being GAAP-compliant limits access to financing and partnerships requiring accrual-based financing.

What are the pros and cons of accrual accounting?

Accrual accounting offers several benefits but also comes with its own set of challenges. The pros and cons of accrual accounting are below.

Pros

• It provides a more accurate representation of a business's financial performance by matching income and expenses to the periods in which they're earned or incurred.

• This helps to assess patterns and long-term profitability and make informed business decisions.

• Accrual accounting aligns with GAAP, which is essential for compliance and credibility.

Cons

• It is more complex and requires meticulous record-keeping, potentially leading to higher implementation costs.

• Accrual accounting may not reflect cash flow accurately, posing challenges for businesses with limited liquidity.

What is a hybrid method of accounting?

A hybrid method of accounting combines elements of cash and accrual accounting.

This ensures it offers the benefits of accrual and cash accounting while mitigating their respective limitations. 

Cash accounting focuses on actual cash flow, while accrual accounting emphasises matching revenues and expenses.

Hybrid accounting blends these approaches, providing a comprehensive yet adaptable framework that can suit various businesses and help them remain compliant. 

For example, using the hybrid method of accounting allows businesses to use cash accounting for certain transactions and accrual accounting for others.

The choice will depend on what makes the most sense for the business's accounting needs.

This approach offers flexibility and customisation to small business accountants and caters to each company's requirements. 

Seek expert financial advice

Cash and accrual accounting methods differ in when they allocate income and expenses. 

Cash accounting tracks transactions based on cash flow, offering simplicity but potentially overlooking long-term financial health.

Accrual accounting, on the other hand, matches income and expenses to the periods in which they are earned or incurred.

This accounting method provides a more accurate picture of a business's performance but requires meticulous record-keeping.

The hybrid method of accounting combines elements of both approaches for increased flexibility. 

For tailored advice on accounting practices best suited to individual businesses, let Unbiased match you with a qualified accountant today.