How does cash accounting differ from accrual accounting?

Cash accounting is characterized by its method of recognizing income and expenses only when cash changes hands. Under this system, expenses are recorded at the time they are paid, meaning that if a business incurs an expense but does not pay for it immediately, that expense is not recorded until the cash is disbursed. This approach provides a straightforward view of cash flow, which is particularly beneficial for small businesses that need to track real-time cash availability.

In contrast, accrual accounting operates on the principle of recording revenue and expenses when they are earned or incurred, regardless of when cash transactions occur. This means that a business will recognize income when a service is provided or a product is delivered, rather than when payment is actually received. Similarly, expenses will be recorded when they are incurred, not necessarily when they are paid.

This distinction is vital for understanding financial performance over different accounting periods, as accrual accounting can provide a more accurate picture of a company’s financial health and obligations, reflecting liabilities and receivables that cash accounting might overlook.