Does your business use cash basis accounting or accrual accounting? What makes the two methods different is the timing of when sales and/or purchases are recorded in your accounts. Cash basis only recognizes income and expenses when money has been actually been exchanged. Accrual recognizes income and expenses as they’re earned/billed, whether they’ve been paid or not.
Cash basis accounting focuses on the actual exchange of money. It’s not income until the cash is received, and it’s not an expense until the bill has been paid. Only then will it be recorded. Because of this, there is no need to track accounts receivable or accounts payable. Many small businesses choose to go with this method of accounting since it’s simpler and easier to maintain. With cash basis, you don’t have to wonder how much money your business has at any given time, you just need to look in your bank account.
With accrual accounting, the expenses and income are logged whether the money has actually been exchanged or not. This method is the more common of the two. Because you’re logging transactions as they happen and not when they’re paid, this provides you with a more realistic look at your income and expenses over a period of time. Accrual accounting allows you to see the bigger picture, but makes cash flow much harder to follow. While your business may appear profitable, you could have an empty bank account. With the accrual method, just be sure to put the time in to check on your cash flow.
Each of these methods has a different effect on cash flow. It’s income stream versus cash flow, really. If you record the same transactions for the same company over the same period of time using both cash basis and accrual, the income and profit for the company will likely be different. It’s all about the timing.
If you’re unsure which method is right for you, consult a trusted CPA, bookkeeper, or accountant.