Accrual vs. Cash Accounting

Cash accountingrecords revenue and expenses only when cash actually changes hands — a sale counts when payment is received, a bill counts when it's paid.

Accrual accounting records revenue and expenses when the underlying transaction happens — when a sale is made or a cost is incurred — regardless of when the cash actually moves. A sale made on credit counts as revenue immediately, even though the cash arrives later.

A business rarely gets paid the exact instant it delivers a product or service, and rarely pays its own bills the instant it receives them — money is often owed in both directions for a while before cash actually changes hands. That gap creates a real question: does a sale "happen" when the customer promises to pay, or when the cash actually lands in the business's account? Does an expense "happen" when a bill arrives, or when it's actually paid? Cash accounting and accrual accounting are two different, internally consistent answers to that question.

Cash accounting is the simpler answer: record it when the cash moves, full stop. It's straightforward and hard to get wrong, which is why many very small businesses and individuals use it — a personal bank balance is effectively a cash-basis record. But it can paint a misleading picture of a business's health in any single period: a company could look wildly profitable in a month it happens to collect old unpaid invoices, and look like it's struggling in a month it's actually thriving but simply hasn't been paid yet.

Accrual accounting exists to fix that mismatch: it ties revenue and expenses to the period the underlying activity actually happened in, whether or not cash has moved yet, so a business's reported results in a given period reflect what it actually did during that period, rather than just when its bank account happened to be credited or debited. This is why the financial statements built from a company's books are usually prepared on an accrual basis for any business large enough to be meaningfully compared period to period — it's the standard most investors and lenders rely on precisely because it isn't distorted by the timing of cash payments.

Maria's bakery delivers a $1,000custom cake order to a corporate client on credit in late December. The client doesn't actually pay until January.

Cash accounting:
  December: $0 revenue (no cash received yet)
  January:  $1,000 revenue (when payment arrives)

Accrual accounting:
  December: $1,000 revenue (the sale happened; a $1,000
            "accounts receivable" asset is recorded)
  January:  $0 new revenue — the $1,000 receivable simply
            converts into $1,000 of cash

Under cash accounting, all of December's baking, ingredients, and labor for this order show up as zero revenue that month, even though the work was fully done. Under accrual accounting, December's results reflect the sale that actually happened in December.