What is this? It’s understanding forms an important basis for managing a business.
Cash Basis of accounting is when you record in your accounting books, only monies that are collected and monies that are paid out. Under this basis, customers pay you in cash, check or credit card. You deposit all these monies in your Bank and this becomes your Sales. Similarly, you write checks or use credit cards to pay your bills. Only when monies leave your Bank or when you pay your credit card account, is the expenses recorded in your books. This works well, while your business is small and transactions are straightforward.
Now as you grow and your transactions multiply and become complex. A cash basis of record keeping is unable to give you a up to date understanding of your business. You may be giving credit to your customers and these are unknown until paid; its’ your sales and accounts receivable. You will incur costs to be paid later (and it is not recorded until paid) it is your purchases and accounts payable. When you bring all these transactions ‘in-house’ immediately, as it is incurred then you are moving to an accrual basis of accounting. Such a basis is preferred, as recording commitments made to you and by you instead of waiting for cash to pass through, enables you to control your business better. Transactions, whether paid for or not, are recorded at the commitment stage which is the essence of accrual accounting.
This then is a simple explanation of the difference between cash and accrual accounting.
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