Let's talk about cash versus accrual basis for accounting purposes. In a later post I discuss cash versus accrual for tax purposes.
The cash basis and accrual basis are two different ways of recognizing revenue and expenses. Recall that revenue are funds coming into the business for doing business activities and expenses are the cost of doing those activities.
For the cash basis revenue and expenses are recognized when cash exchanges hands. So when someone pays me for a service or for goods they purchased from me, regardless of when that service was performed or those goods exchanged hands, I record revenue. When I pay expenses, regardless of when my bill came, I record the expenses.
On the other hand with the accrual method when I perform those services or those goods exchange hands I record revenue regardless of whether or not the customer has paid me. When I receive a bill I record expenses even if I have not paid that bill yet.
So why does this matter? Well to put it simply, with the cash method I can choose when to pay expenses and therefore when to recognize them. It is easier for me to manipulate my net income (in a legal way). It is a little harder to manipulate revenue because I don't have as much control over when someone pays me. With the accrual method everything is recorded when incurred. Because of this the accrual method is often thought of as a method that provides a clearer picture of the financial status of a company. It is also the method that is required for most large companies for this reason.
Only certain people can use the cash method for external reporting and tax purposes (reports can be run in both the cash and accrual method for internal purposes regardless of what you are required to use for external purposes). In another blog I discuss who is and who is not allowed to use the cash method for tax purposes.