Shownotes
If you’re DIYing your books, you likely don’t know when to use accrual vs. cash basis accounting.
This is one of the red flags we see when new clients start working with us.
Most sole proprietorships, single-member LLCs, and S-corps are using cash basis accounting because it’s simple — it’s the cash you’ve collected.
But if you are ready to scale your business, you need to understand and use accrual accounting, which is going to allow you to know when (and how much) you can invest in additional expenses and how to maintain a cash-healthy business so you never find yourself unable to pay yourself or your bills.
Tune into this episode to learn the differences between accrual vs. cash basis accounting, when to use each one, and how understanding accrual accounting is going to make it more sustainable for you to scale.
01:31 — What is Accrual vs. Cash Basis Accounting?
03:45 — When to use Accrual vs. Cash Basis Accounting
05:43 — How Looking at Accrual Accounting Can Help You Make Better Financial Decisions to Scale Your Business
12:22 — Mistakes to Lookout for When Using Accrual vs. Cash Basis Accounting
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Transcripts
Accrual accounting shows a more accurate reflection of the financial
Speaker:health of the company overall.
Speaker:And it'll help you from making rash decisions on spending just
Speaker:by looking at that cash balance or the cash you've received.
Speaker:It's like fortune telling.
Speaker:Yes.
Speaker:Kind of on your accounts.
Speaker:Exactly.
Speaker:Welcome to the Know Your Worth Show, where we teach you how to think about
Speaker:your money differently so that you can achieve your sexy money goals.
Speaker:I'm Sydnee your money Maven and owner of Know Your Worth.
Speaker:And I'm Kristen Sid's Dimepiece bestie team member and busy mama
Speaker:twins here to make sure that those of us without a financial degree can
Speaker:still level up with each episode.
Speaker:Let's get started on reaching your next goal.
Speaker:Hello.
Speaker:Hi.
Speaker:Welcome to the Know Your Worth podcast.
Speaker:I am one of your hosts, Sydney Conway.
Speaker:And I'm your other host, Kristen Fedeli.
Speaker:Yes, this is, uh, we're in our, what, 20 something episode now.
Speaker:I think this is 22.
Speaker:Oh, how exciting.
Speaker:It's a good number.
Speaker:I like 22.
Speaker:That was my college softball number.
Speaker:I don't know about you.
Speaker:But I'm feeling 22.
Speaker:Yeah.
Speaker:Didn't we already use that joke?
Speaker:I don't know.
Speaker:I thought we did.
Speaker:So is this our 23rd episode?
Speaker:Here we go though, regardless.
Speaker:Well, exactly.
Speaker:We're going to get right into it.
Speaker:We're going to, we're going to dig into a concept today that sometimes can be
Speaker:a little bit confusing for people that just don't have an accounting background.
Speaker:Consider me confused already.
Speaker:Yeah.
Speaker:It's accrual versus cash basis accounting.
Speaker:Yep.
Speaker:Don't let your eyes glaze over just yet.
Speaker:No, I'm ready.
Speaker:Okay.
Speaker:I'm ready.
Speaker:Let's do it.
Speaker:Accrual versus cash basis accounting it's the method of accounting that you're
Speaker:using when you're tracking your financial statements and it also goes into kind
Speaker:of the processes of your business if you wanted to get very granular and very deep.
Speaker:I am going to talk about this, not necessarily in a really intense way
Speaker:that you would as like an auditor.
Speaker:That can get very intense for accrual basis versus cash basis.
Speaker:And I'm not going to get like really vast into it.
Speaker:In a very simple concept, Mhmm accrual basis accounting recognizes income
Speaker:and expenses when the event occurs.
Speaker:Cash basis recognizes income and expenses when the cash is exchanged.
Speaker:That's a very simplified way.
Speaker:So for example,
Speaker:I mean, I was like, I'm going to need an example.
Speaker:Real life.
Speaker:Real life.
Speaker:For example, if you go to a lemonade stand,
Speaker:I would love to,
Speaker:and you say, I want to buy a lemonade.
Speaker:And they give you the lemonade and you give them money for it.
Speaker:Yes.
Speaker:That's a cash transaction.
Speaker:Got it.
Speaker:If you were to go to a lemonade stand and you were to say,
Speaker:Hey, I want to buy a lemonade.
Speaker:I'm not going to pay you right now.
Speaker:I'm going to pay you next week.
Speaker:Mm hmm.
Speaker:They give you the lemonade, but you don't give them any money.
Speaker:Mm hmm.
Speaker:Accrual basis accounting says that the lemonade stand recognizes
Speaker:that as income that day.
Speaker:Mm hmm.
Speaker:Because you got the lemonade.
Speaker:Yeah.
Speaker:Cash basis says that they don't recognize it as income until they receive the cash.
Speaker:Okay.
Speaker:Which is next week.
Speaker:Okay.
Speaker:That's the difference.
Speaker:Okay.
Speaker:Same thing with expenses.
Speaker:Say you're going to buy the sugar for the lemonade.
Speaker:And so now you're the lemonade stand owner and you're buying sugar.
Speaker:You put in the order, you receive the sugar, but you haven't paid it yet.
Speaker:Your payment terms are net 30, so you don't have to pay them for a month.
Speaker:Okay.
Speaker:Accrual basis says that that bill is as of that day, the day you order it and the
Speaker:day that you get the sugar, it is yours.
Speaker:If you are cash basis,
Speaker:It's not till the 30 day mark.
Speaker:It's not till the 30 day mark when the cash leaves.
Speaker:You did it.
Speaker:You explained it.
Speaker:Yeah.
Speaker:Yeah.
Speaker:Exactly.
Speaker:I got it.
Speaker:Accrual versus cash basis accounting.
Speaker:Woo.
Speaker:Now you know I have 10 questions.
Speaker:Yeah.
Speaker:Absolutely.
Speaker:So what are the first ones?
Speaker:Why would you use cash basis versus accrual or vice versa?
Speaker:Mm hmm.
Speaker:A lot of this goes into like overarching principles, but most of the businesses
Speaker:that are listening to this podcast, most of the single member LLCs, the sole
Speaker:proprietorships, the even S corps are cash basis businesses for tax purposes.
Speaker:Okay.
Speaker:So you file your taxes, cash basis, even though you might look at your
Speaker:financial statements throughout the year on an accrual basis.
Speaker:Okay.
Speaker:That means that say you had sent a bunch of invoices in
Speaker:December for work that you did.
Speaker:But your customers didn't pay you until January.
Speaker:You file your taxes off of the money you actually received in your bank account.
Speaker:So you're not paying the IRS, the government, money
Speaker:'til the following year.
Speaker:On money you don't have.
Speaker:Yeah.
Speaker:You don't actually have that cash in the bank.
Speaker:Okay.
Speaker:So you're not gonna pay the taxes on it.
Speaker:Because what are you gonna pay taxes on?
Speaker:Oh, you, say you did a million dollars in sales in December,
Speaker:but you didn't collect it.
Speaker:Right.
Speaker:So you don't want to file a report to the IRS that says, I made a million dollars
Speaker:in sales and you don't have that money.
Speaker:Because then they're going to say, oh great, you owe us the
Speaker:taxes on that million dollars.
Speaker:Right.
Speaker:But you don't have the cash.
Speaker:Right.
Speaker:So how are you going to pay?
Speaker:So you don't file your taxes on that money when you were a cash basis company.
Speaker:You only file your taxes on the money you've received.
Speaker:Got it.
Speaker:And I have to apologize.
Speaker:I have a really strong Pittsburgh accent I'm feeling like today.
Speaker:So like, I just said file.
Speaker:Did you say file?
Speaker:I said file like three times.
Speaker:I didn't hear this.
Speaker:I said file.
Speaker:And then the last time I said it I was like file.
Speaker:So sorry if you're not from Pittsburgh.
Speaker:You probably are like wow this girl right here is saying foul, which I say iron.
Speaker:You guys are saying foul.
Speaker:Yeah.
Speaker:At golf lessons I say iron and I'm like, oh gosh, iron, iron.
Speaker:Get your iron out.
Speaker:I didn't even notice it.
Speaker:Yeah.
Speaker:I've been saying foul.
Speaker:I was trying so hard not to be saying cash and accrual.
Speaker:So when you file your taxes.
Speaker:Got it.
Speaker:Filing my taxes.
Speaker:Yes.
Speaker:Most businesses that are listening to this podcast are probably cash
Speaker:basis businesses that are filing their taxes on cash basis reporting.
Speaker:Got it.
Speaker:But there are, you can toggle back and forth.
Speaker:And so if you're using QuickBooks online, you can toggle back and forth
Speaker:so you can see your reports on an accrual base basis and on a cash basis.
Speaker:The reason why you would want to look on an accrual basis is because not all the
Speaker:time, but most of the time, depending on the nature of your business, I should
Speaker:say, it's a more accurate reflection of like the workload for the year.
Speaker:So for example, we have a lot of florist clients and they will invoice their
Speaker:clients for weddings and they invoice them for the date of the wedding.
Speaker:So the invoice is the wedding date.
Speaker:And then also their expenses are incurred as the wedding approaches.
Speaker:So when the wedding month comes, they recognize that income as income in
Speaker:that month, and those expenses when they're, you know, purchasing all the
Speaker:flowers and the vases are that month.
Speaker:Got it.
Speaker:But they might not get paid on that wedding until the following
Speaker:month, or they might have to take a deposit on that wedding, and they
Speaker:might get paid four months before.
Speaker:So if you're looking at your reporting, and you're seeing Oh, I have this
Speaker:massive piece of income in April, but I have tons of expenses in May.
Speaker:So it looks like I have a loss in May, but I have a big income in April,
Speaker:well it's all for the same wedding.
Speaker:Got it.
Speaker:So if you were to run that report on accrual basis, you would see the income
Speaker:in the month of the wedding and the expenses in the month of the wedding.
Speaker:So you would know, Oh, that was a busy month.
Speaker:It's because of this one wedding.
Speaker:Yeah.
Speaker:We received money at different points.
Speaker:But like the work happened in this month, so it can be a much clearer analysis
Speaker:for when the actual workload occurs too.
Speaker:So that way you're not kind of planning for the wrong stuff.
Speaker:But you definitely want to look at it for both ways because if you are
Speaker:someone that doesn't have consistent cash flow month to month, you're not
Speaker:on a membership basis or a recurring revenue basis, you want to look at when
Speaker:you're actually receiving that cash.
Speaker:Because you might be billing in different times and receiving it different times,
Speaker:but the expenses come in different months.
Speaker:So, again, say you have this big deposit for a job that's in three months.
Speaker:You in your head are thinking, wow, I have so much money right
Speaker:now and I barely have any expenses.
Speaker:And then you spend the money and then that month comes where the expenses happen.
Speaker:And you are thinking, oh crap, I don't have any more money.
Speaker:So you want to look at it both ways to kind of know.
Speaker:All right, I have cash, but it's because this is coming up.
Speaker:Yeah, got it.
Speaker:Yeah, so those are kind of the main differences there.
Speaker:Yeah.
Speaker:Does that make sense?
Speaker:It does.
Speaker:So how does this apply to the clients that you work with at know you're worth?
Speaker:So, like I said, most of our clients are cash basis.
Speaker:We do have a couple that are accrual basis for their taxes, and that
Speaker:means that they will pay money.
Speaker:They will owe taxes on money they haven't necessarily received yet.
Speaker:So we need to make sure that all of their invoices are entered, but we also need to
Speaker:make sure all of their bills are entered because they also are getting that tax
Speaker:deduction on bills that they have received that haven't been paid by them yet.
Speaker:So we need to make sure that both sides of the the transaction are in there.
Speaker:So that way they are paying the true reflection.
Speaker:It's not based off of just the income and we didn't put the bills in.
Speaker:So for our clients, like I said, most of them are cash basis, but we want to
Speaker:make sure that we explain the reports before we send them, if they're not
Speaker:aware, because this is where I was
Speaker:like logging into your doctor account and like your blood work comes back
Speaker:and then you immediately panic.
Speaker:Yes.
Speaker:Yeah.
Speaker:Cause you see like unremarkable and you're like, well, what's that mean?
Speaker:Or the range is this and you're like Googling.
Speaker:Or you see negative, but it just means that like nothing came up in the scan
Speaker:and you're like, oh gosh, negative.
Speaker:I don't like negative.
Speaker:Yeah.
Speaker:The words that they use are the opposite.
Speaker:Sending financial reports.
Speaker:Yeah.
Speaker:Before explaining them is probably just as anxiety inducing.
Speaker:Yes.
Speaker:We just had a client last week reach out and was like, Oh my gosh, this looks
Speaker:so much lower than what it should be.
Speaker:You know, I'm seeing this much revenue in our bank account.
Speaker:When I just do a quick analysis of our bank account, I can
Speaker:see this much money came in.
Speaker:And so then I have to say, oh, okay, wait, yeah, I, I sent you the accrual basis
Speaker:because you invoice out of your system.
Speaker:So most of the times the clients that we work with that do invoicing out
Speaker:of QuickBooks like to see the accrual based statements because they want
Speaker:to see how much they've billed, how much work have they put out there.
Speaker:Yeah, not necessarily what they've received back.
Speaker:Got it.
Speaker:So I sent this person accrual basis statements It was a newer client just
Speaker:because that they do invoicing, that's kind of my assumption with a lot of our
Speaker:clients, and I said let me run the cash basis and I ran the cash basis and it
Speaker:was still off maybe a couple hundred thousand dollars this is a larger client.
Speaker:And the other portion of that was because money came into the business
Speaker:that wasn't income like it was a loan that they received in it.
Speaker:So that increased their cash balance, but not their sales.
Speaker:That was kind of the other filling in the gap.
Speaker:So sometimes we just have to make sure we know who we have to fill in the gap for.
Speaker:And that's fine.
Speaker:That's what we're here to do.
Speaker:But a lot of the times it is.
Speaker:Just knowing what you're looking at.
Speaker:Uh, we have another client that's a law firm.
Speaker:So we do all of their billing for them.
Speaker:We send all their invoices on, you know, the first week of
Speaker:the month for the prior month.
Speaker:So when they run the reports for the prior month, they see all of
Speaker:the billing we did the next month.
Speaker:The next month.
Speaker:So we have to watch, like, all of the cash that they receive for the work they did
Speaker:the prior month comes in the following month or even a little bit later.
Speaker:Got it.
Speaker:So they want to see, yeah, how much did we bill because they want
Speaker:to know how much work they did.
Speaker:Right.
Speaker:But then also they do want to know, okay, do we have enough cash coming in?
Speaker:What does that cash flow look like?
Speaker:Interesting.
Speaker:Yeah.
Speaker:So it's just another way to, like, get a full snapshot of
Speaker:somebody's books and accounting.
Speaker:Yeah.
Speaker:Accrual accounting shows like a more accurate reflection of like the
Speaker:financial health of the company overall.
Speaker:And it'll help you from making rash decisions on spending just
Speaker:by looking at that cash balance or the cash you've received.
Speaker:It's like fortune telling.
Speaker:Yes.
Speaker:Kind of on your accounts.
Speaker:Exactly.
Speaker:Hmm.
Speaker:Instead of living your life one mile at a time like I do.
Speaker:Hey, you're good.
Speaker:And if you don't invoice clients, you might really not have a
Speaker:difference between your statements for cash basis and accrual basis.
Speaker:If you're, if you're somebody that sells a product, and so when you sell the product,
Speaker:you make the money, and when you buy the piece of equipment, or you buy the shirt,
Speaker:you sell the shirt, it's all cash basis.
Speaker:You're not kind of extending that float time between when you're
Speaker:receiving and when you're spending.
Speaker:It's all cut and dry.
Speaker:It might be exactly the same.
Speaker:If you run your cash basis versus your accrual basis accounting in QuickBooks,
Speaker:you might see the exact same numbers.
Speaker:Interesting.
Speaker:What else do we need to know about this?
Speaker:So I think that for anybody that does do invoicing, it is just really understanding
Speaker:the difference between the two.
Speaker:Because if you don't look at them, you might not be planning for taxes correctly.
Speaker:So if you're looking at them based off of accrual accounting, you might not
Speaker:be planning for your taxes correctly because you're not looking at what you're
Speaker:actually going to owe in those taxes.
Speaker:So that's one of the things you definitely want to take a look at.
Speaker:The other thing is misinterpreting financial statements in the reports that
Speaker:you're looking at, because you might be thinking, Oh, I made so much money,
Speaker:but there's no cashflow or, Oh, wow, there's no bills this month, but it's
Speaker:really that they just see that the cash hasn't come out or did you not enter
Speaker:the bill for last month or this month?
Speaker:You know, you need to make sure that the statements are correct in that way.
Speaker:Those are some of the main ones but you also want to make sure that you
Speaker:don't have requirements to people for Cash basis or a quo basis accounting.
Speaker:So technical, technically as a business, you want to do "GAP" accounting, which
Speaker:is the generally accepted accounting principles, which is kind of like the,
Speaker:where, where accounting comes from, or, you know, who is in charge of what
Speaker:accounting is, they're the, the, the AICPA, the uh, you know, the Accounting
Speaker:Society, they're the rule setters for accounting and gap accounting which is
Speaker:like a whole governing body of people that basically tell you what's right and wrong.
Speaker:And auditors are the ones that are really looking at this whenever
Speaker:they're going into large companies.
Speaker:And pretty much everywhere they're looking, their clients need to
Speaker:be accrual basis accounting.
Speaker:Taxes are a different story.
Speaker:But for financial statements, for different loans and bank requirements
Speaker:or grants and funding, they want to look at things in accrual basis accounting.
Speaker:They want to see the whole entire picture.
Speaker:And again, if you are a business that just is like really transactional, it
Speaker:might not be a huge difference, but you want to make sure that if, if you are
Speaker:someone that's looking to really grow and scale that you do know the difference
Speaker:between the two, because if you ever do have a requirement for an audit, you
Speaker:want to make sure that you are recording things correctly and that you're not
Speaker:recording bills at the wrong time or receiving income at the wrong time.
Speaker:So again, that's kind of like a next step, and we can get into that later
Speaker:on for sure too, if you're a company that's growing and scaling or looking
Speaker:to get a big investment, looking to get financing in any capacity, you just
Speaker:want to make sure that you are doing the proper accounting for whatever
Speaker:the requirements of that funding or of that grant or of that stipulation is.
Speaker:Yeah, it feels like you could get in really big trouble if
Speaker:you don't understand this.
Speaker:Yeah.
Speaker:I mean
Speaker:Or like very confused.
Speaker:You can get very confused.
Speaker:You can get very confused.
Speaker:Because generally, like if, as long as you're doing things right and
Speaker:you don't understand it, you can kind of just toggle back and forth.
Speaker:If you're entering things incorrectly you won't necessarily get in trouble.
Speaker:It just might be, Hey, can you rerun this in cash basis or, Hey, can
Speaker:you rerun this in accrual basis?
Speaker:But you just want to make sure that you're entering dates in correctly
Speaker:into your accounting system and that you are recording all of the
Speaker:transactions that need to be in there.
Speaker:And I can see where it would behoove you to have a bookkeeper in this
Speaker:situation, especially if you were a client who invoices people and get paid
Speaker:way later, or, yeah, I can see how it would be nice to have squeaky clean
Speaker:books and have another set of eyes.
Speaker:Exactly.
Speaker:And it is very nice to see, like, I, I spend a lot of time toggling
Speaker:back and forth between like, our accrual and our cash basis.
Speaker:I mean, for me, the way that I look at it is typically in like our AR reports,
Speaker:who's paid us this month and who hasn't.
Speaker:Most of our clients are set up on auto recur or auto bill, but there's
Speaker:a couple that, you know, pay us on their own and they send us checks.
Speaker:So I do look at, okay, you know, how was the cash flow this month?
Speaker:And there are the months where you look at it and you're like,
Speaker:wow, we made so much money.
Speaker:Well, no, we billed a lot , but that doesn't mean we got paid for it.
Speaker:So.
Speaker:I want to make sure that I know when I'm receiving the cash.
Speaker:What does that cash flow for our business look like?
Speaker:Don't make rash decisions based off of sending a big bill,
Speaker:because what if they don't pay you and you have to write it off?
Speaker:Exactly.
Speaker:Exactly.
Speaker:Yeah.
Speaker:Another thing to be on the lookout for in the world of taxes and accounting.
Speaker:Yes, absolutely.
Speaker:So there's not too, too many red flags here.
Speaker:I know we're, we, this is one of our red flag episodes, but it's mostly just
Speaker:understanding the concept and knowing how it impacts your business specifically and
Speaker:knowing what questions to ask if it does, uh, what reports to run, who to talk to.
Speaker:And so we're, we are here to help if you need us in this this piece.
Speaker:Let us know if you hated this episode or if you've loved it.
Speaker:We hope you loved it.
Speaker:Because accounting can be accrual.
Speaker:I can't even like, that was so good.
Speaker:I missed it.
Speaker:My dad listens to all of these episodes and, uh, I have to say
Speaker:this past weekend, so he always does that, but I'm, but he can't do it.
Speaker:So he goes like, ba da bum tsh tsh tsh tsh.
Speaker:He does like the extra version.
Speaker:Like the remix.
Speaker:Exactly.
Speaker:So Dad, when you listen to this episode, ba da bum Smires.
Speaker:Alright, on that note, have a wonderful day, everybody.
Speaker:Have a great day.
Speaker:See ya.
Speaker:And, uh, I hope your day is not too accrual.
Speaker:Alright, until next week.
Speaker:Bye.
Speaker:Bye.
