Cash basis or accrual basis for a small business?
How the cash basis and the accrual basis differ, why accrual shows the truer picture, and what an owner sees when invoices and bills post as issued.
By Achekam · · 5 min read · For Running a business businesses in South Africa, Nigeria, Kenya
Ask two owners how their month went and you may get two different kinds of answer. One looks at the bank balance: more came in than went out, so it was a good month. The other looks at the invoices sent and the bills received: the work done was worth more than it cost, so it was a good month. Both are describing something real. They are simply keeping score on different bases.
Which basis your books use decides when a sale counts as a sale and when a cost counts as a cost. It changes the profit figure in any given month, sometimes by a lot, and it changes what a banker or investor will make of your figures.
When cash moves versus when it is earned
Investopedia explains the cash method simply: it recognises transactions only when there is an exchange of cash. A sale is income on the day the customer pays. A supplier's bill is an expense on the day you pay it.
Accrual accounting, as Investopedia defines it, matches revenue and expenses to the period in which they are incurred rather than when cash changes hands. Under accrual, a company records revenue before receiving payment for goods or services sold, and records expenses as they are incurred.
A worked example in words. A Lagos printing business finishes a large brochure job at the end of March and invoices it on the last day of the month. The client pays at the end of April. The paper for the job was bought on credit in March and paid for in May.
- Cash basis: March shows nothing for the job. April shows the full sale as income. May shows the paper as a cost. The job looks wildly profitable in April and loss-making in May.
- Accrual basis: March shows the sale and the paper cost together, because that is when the work was done and the cost incurred. April and May show only the money moving in and out, which changes what is owed, not the profit.
Why accrual gives the truer picture
Investopedia notes that the accrual method gives a more accurate picture of a company's condition. The printing example shows why: under accrual, the profit on the job sits in the month the job was done, beside the costs that produced it. Under cash, the timing of payments drives the result.
Accrual also tells you things cash cannot:
- how much customers owe you, and how old those debts are;
- how much you owe suppliers, so a healthy bank balance does not hide a pile of unpaid bills;
- whether a month's work was actually profitable, regardless of when customers settled.
The price, Investopedia adds, is that accrual is more complex and so more expensive to implement, which is why many small businesses use cash accounting. That trade-off was real when every entry was handwritten. It matters less when the software makes the accrual entries as part of normal invoicing.
The modified cash basis
Investopedia lists three accounting methods: the cash basis, the accrual basis and a hybrid called the modified cash basis. A hybrid typically keeps day-to-day income and expenses on a cash footing while treating longer-lived items, such as equipment, more like accrual, so a large purchase is spread over the years it is used.
It can be a reasonable stepping stone for a very small business, but it shares the main weakness of the cash basis: you still do not see what customers owe you or what you owe suppliers in the figures.
Which basis you may use for tax, and whether financial statements for lenders or shareholders must be on accrual, depends on your country and your circumstances. Settle that question with your accountant before you choose.
How Achekam records invoices and bills
Achekam keeps each business's books in its own double-entry ledger, set up with a standard chart of accounts when the books first open. The way it records sales and purchases puts you on the accrual basis by default:
- Customer invoices. You draft an invoice, change or delete it while it is a draft, and issuing it takes the next number in its sequence and posts it to the ledger as debtors, sales and output VAT. The sale is income on the day the invoice is issued, not the day it is paid.
- Customer payments. A payment is recorded against one invoice or spread across a customer's invoices. A part payment leaves the invoice part-paid, and any extra is held on the customer's account. The receipt reduces what the customer owes; it does not create a second sale.
- Supplier bills. You record supplier bills line by line with VAT. A bill without a purchase order waits for approval before it posts. A bill can then be paid in full or in parts from a chosen bank account.
Because invoices, receipts and bills all post straight to the same ledger, nobody has to rebuild the accruals at month-end from a spreadsheet of who owes what.
What changes for the owner reading the figures
Achekam's management accounts show an income statement for a chosen period beside the period before, and a balance sheet at period end, both added up from the business's own journals. On the accrual basis, read them like this:
- Profit is not cash. A strong month on the income statement can coexist with a thin bank balance if customers have not paid yet. See why a business can show profit but have no cash.
- The balance sheet carries the timing. Trade receivables show sales not yet collected; trade payables show costs not yet paid.
- Money received before you deliver is not income yet. Accrual has a mirror image: a deposit for work you have not done is owed back to the customer until you do it, covered in why money received in advance is a liability.
Investopedia's article on accrual accounting and how it differs from the cash method has more on the two methods. If your books have been kept on cash until now, ask your accountant to bring in the unpaid invoices and bills at the date you switch, so the first accrual month starts from the right place.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
