The main difference between cash and accrual (non-cash) accounting is timing.
If you record revenue or expenses when you pay and receive money, you’re using cash-basis accounting. This is the simplest method and is suitable for most smaller businesses who handle cash transactions. It can only be used if your aggregated turnover is less than $10 million, or if you use cash accounting for income tax.
If you wait until you raise or receive an invoice to record revenue or expenses, then you’re using accrual accounting. This can be a far more powerful tool for managing a business and is suitable for businesses that don’t get paid straight away.
Pros and Cons
Benefits of cash accounting
- It’s simple and shows how much money you have on hand, making it easier to manage cash flow.
- It’s an easier option for calculating GST.
Disadvantages of cash accounting
- It doesn’t accurately show your profitability – you might look profitable simply because you haven’t paid your bills.
- It not as useful when making management decisions, as it only shows a day-to-day view of your finances.
Benefits of accrual accounting
- It gives you an accurate picture of your business performance and finances, allowing you to make more informed management decisions.
- Using this method can be more successful when pitching for long-term finance.
- You can claim GST upfront on unpaid expenses upfront.
Disadvantages of accrual accounting
- It’s more work because you have to watch invoices, not just your bank account.
- You may have to pay tax on income before the customer has actually paid you.
It is possible to use a hybrid accounting system. For example, you could base big financial decisions such as loan applications on accrual accounting but use cash-basis accounting to simplify some elements of your tax.
However, there are lots of rules around who can and can’t do this, so please speak to us to find out what applies to you. You’ll also likely need smart accounting software that can switch between cash-basis and accrual-basis as needed.