As a new business owner, one of the first things to consider when setting up your company in QuickBooks is whether you want to use a cash or an accrual method for recording income and expenses. Each has it’s own set of rules to follow, but the main difference between cash vs. accrual accounting is the timing of when items are recorded. Service based companies have the option to elect either method since they generally do not carry inventory.
Cash accounting recognizes income and expenses on the date that the transaction occurs. For example, the date that a check is deposited to your bank account, or the date that a purchase was made. If you are writing a check on the 25th of the month to pay rent for the upcoming month, the rent is recognized on the day the check was written. While the cash method is easier to use, electing to use a cash basis for accounting means that outstanding invoices do not factor into your profit for the period, and expenses are not counted until the moment they are paid for.This method may be better for your business if you have little cash on hand or an unpredictable collections cycle so that it does not hinder cash flow performance.
The accrual accounting method recognizes income when it is earned, and expenses when they are incurred (not paid). While a little more complex than cash accounting, the accrual method records an entry (accrual) for known income or expenses in the period it is associated with. For example, If rent was paid on the 25th of the month for the upcoming month, it is recognized as an expense in the upcoming month. The accrual is basically a “placeholder” until you arrive at the period it is intended for. Accrual based accounting provides a more accurate picture of performance, and better matches expenses with income.
While there are pros and cons to each method, we generally recommend accrual accounting as that provides a better picture of true company profitability or loss.
Want to discuss how we support professional service firms in managing their outsourced bookkeeping and accounting. Contact us for a complimentary review.