This is a tricky one because sometimes I get lost on this and it takes me a minute to get my bearings.
Simply put, it’s how you define the timing of a financial transaction in your business.
If you run a retail or wholesale business, virtually all of your transactions are done on a cash basis. That is, if you have sold $1,000 worth of goods today, then you can recognize $1,000 in revenue for the day.
If you run a service-based business, especially if it’s professional or creative services, then you probably want to run both accrual and cash basis. For example, let’s say today you billed a client $10,000 in services rendered. Your revenue for the day is $10,000 on accrual basis.
However, in cash basis this revenue will not show, at least not until you receive payment.
When I help my clients understand this accounting concept, I give this rule of thumb — accrual basis is performance while cash basis is money in and out of the bank.
Looking at an Income Statement on Cash Basis is great for reviewing the money coming in and out of the business in a given period, but you don’t get the full picture. If you have clients paying your bills with net terms, you don’t really have full control over when your clients pay. (This is why invoice factoring is such a huge industry and you definitely should consider especially if you’re dealing with net terms of 60 days or more.)
An Income Statement on Accrual Basis is really a report on your company’s business performance.
These two types of reporting are also critical when it comes to working with your tax professional and filing your tax returns.
- Thomas Kim from Tabular LLC