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When does a sale count? The moment you agree to it and send the bill, or the moment the money 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

Every sale 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 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 disagree about which moment to record.

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Cash accounting: record when money moves

Cash accounting is the simple one: you record a transaction only when the cash changes hands. You write down money in and money out, and you record nothing until money moves. 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. 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 did.

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Accrual accounting: record when it’s earned

Accrual accounting records a transaction when it’s earned or incurred, not when the cash moves. Finish the work and send the invoice, and that’s revenue now, even if payment is weeks away. Receive a bill for electricity you’ve already used, and that’s an expense now, even if you pay it later. It captures promises, not just cash:
  • Accrual records money customers owe you (but haven’t paid) as revenue and as an asset called accounts receivable.
  • It also records bills you owe (but haven’t paid) as expenses and as a liability called accounts payable.
This gives a truer picture of how the business is really doing in a period. That is because it matches the income to the work that earned it. That’s why larger businesses (and the rules they answer to) use it. This is the same job, $50,000 of work done in December, paid in January, booked under each method: The sale and the $50,000 are the same, but the methods book them 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”

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 arrive next month, or may never arrive at all if someone fails to pay.

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Why profit isn’t cash

The same gap explains why a profitable business can still run out of cash. Profit is revenue minus expenses. 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, 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 why there are two different reports. The Income Statement shows profit. The Cash Flow Statement shows the actual cash. You need both to understand a business.

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Next steps

Next upSee how these pieces run together, period after period, in The accounting cycle.