Accrual vs. cash accounting

Here’s a question that quietly confuses almost every beginner: when does a sale count? The moment you agree to it and send the bill — or the moment the money actually lands in your account? Your answer decides whether you’re doing accrual or cash accounting, and it changes how every report reads.

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Two moments, not one

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Every sale really has two moments:

• The moment you earn it — you deliver the goods, finish the work, send the invoice.
• The moment you get paid — the cash actually arrives.

Sometimes these happen together (you buy coffee, you pay at the counter). Often they don’t — you finish a job in March but the customer pays in May. The two methods simply disagree about which moment to record.

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Cash accounting — record when money moves

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Cash accounting is the simple one: you record a transaction only when the cash actually changes hands. Money in the account? Write it down. Money out? Write it down. No money moved? Nothing to record yet. It works like your personal bank statement. You don’t note that a friend promised to pay you back — you note it when they actually do. Small businesses like it because it’s easy and it mirrors the bank balance you can see. The catch: it can mislead you about timing. Do $50,000 of work in December but get paid in January, and cash accounting says December earned nothing. That’s tidy for taxes but a poor picture of what the business actually did.

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Accrual accounting — record when it’s earned

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Accrual accounting records a transaction when it’s earned or incurred — not when the cash moves. Finish the work and send the invoice? That’s revenue now, even if payment is weeks away. Receive a bill for electricity you’ve already used? That’s an expense now, even if you pay it later. It captures promises, not just cash:

• Money customers owe you (but haven’t paid) is recorded as revenue and as an asset — accounts receivable.
• Bills you owe (but haven’t paid) are recorded as expenses and as a liability — accounts payable.

This gives a truer picture of how the business is really doing in a period, because it matches the income to the work that earned it. That’s why larger businesses — and the rules they answer to — use it. Here’s that same job made concrete — $50,000 of work done in December, paid in January — booked under each method: Same sale, same $50,000 — but the methods book it in different months. Accrual ties the revenue to the work in December; cash waits for the money in January.

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Why revenue isn’t “money in the bank”

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This is the part that catches people out. Under accrual accounting, revenue means money earned — not money received. You can book $10,000 of revenue this month and have none of it in your account yet, because the customers haven’t paid. So when you read an Income Statement and see revenue, don’t picture a full bank account. Picture work that has been done and billed. The cash may already be here, may be arriving next month, or may never arrive at all if someone fails to pay.

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Why profit isn’t cash

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The same gap explains accounting’s most famous head-scratcher: a profitable business can still run out of cash. Profit is revenue minus expenses — and under accrual, both can include things where no cash has moved yet. So your Income Statement can show a healthy profit while your bank account runs dry, simply because customers are slow to pay. The reverse happens too: you can have plenty of cash (a big upfront payment) yet little profit. That’s exactly why there are two different reports. The Income Statement shows profit; the Cash Flow Statement shows the actual cash. As the saying goes: profit is an opinion, cash is a fact. You need both to understand a business.

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In short

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• Cash accounting records money only when it changes hands; accrual accounting records it when it’s earned or incurred, even before the cash moves.
• Under accrual, revenue means “earned,” not “in the bank” — so an Income Statement reflects work done and billed, not your account balance.
• Because of that gap, profit and cash are not the same thing — a profitable business can still be short of cash, which is why the profit and cash-flow reports are kept separate.