Finance Basics: Accrual Versus Cash Accounting

Virtually every business should be run on an accrual basis, which means that the income generated and the liabilities and expenses incurred are recorded within an accounting period, without regard to when the cash is received or distributed. By managing the organization on an accrual basis, it is easier to get a sense of how the business is performing.

When operating on a cash basis, accounting decisions and reporting (including taxation) are governed strictly by the date on which the cash moves in and out of the business. Individual persons operate on a cash basis with respect to taxation.

The majority of organizations will operate the day to day "books" on an accrual basis, because this is the best way to have visibility into how well the organization is performing. These same organizations often pay taxes on a cash basis unless mandated to operate on an accrual basis. If possible, it is often advised to operate on a cash basis in order to guard the precious commodity of cash. It is of little consolation to learn that a tax credit is due when you actually run out of cash!

Operating on an accrual basis is a pretty easy decision.

Determining if an organization is eligible to use the cash method of accounting takes some research. You are advised to retain a competent, professional tax advisor and/or to contact the IRS directly.

Learn more directly from the Internal Revenue Service.

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