The Art of Accounting

Which Method is Best?
The accrual method provides a clearer and more accurate view of a business’ operation because it takes into account all the revenue earned and all the expenses paid or payable within a particular period. Once those two are offset, whether the money has been received in the bank for the sales, or whether the money has been paid out of the bank for expenses a profit or loss will result.

Sometime while operating your business you may be asked whether your accounting system is on a cash or accrual basis. If your sales are cash sales and your purchases are paid when you pick them up, (that is cash purchases) then the answer is easy - you are using a cash accounting basis. If on the other hand you deliver out goods for services, but you are paid at a later date, or if you take in delivery for goods and services, but you don’t pay for them until a later date, then you are operating under the accrual basis.

Each Method produces Different Results
The 2 bases of accounting produce widely different results. If you are already doing business and it’s not strictly cash then you can try both ways. You can choose a month and for that month record cash in and cash out (that is actual payments you receive and actual payments you make) and then add those two columns and subtract the smaller from the larger. You have now created a cash basis profit and loss statement for that month.

Now run the numbers again, but this time include the invoices for sales that you have not received cash for, and include the invoices for purchases that you have not yet paid for. Add the columns and do the same maths again and you will get a different outcome.

In general, the accrual basis is far more accurate because it matches all the income that the business has earned and all the expenses that the business has incurred belonging to a particular period and that period is the period for which you are drafting a profit statement to see whether you have made a profit or not.