Learn It
Every business has to decide when to record a transaction. That decision is called the basis of accounting. There are two common methods: cash basis and accrual basis.
Cash basis is simple. You record revenue when cash comes in. You record expenses when cash goes out. If money has not moved, nothing is recorded. It tracks what happened to the bank account.
Accrual basis is different. You record revenue when it is earned — when the work is done, even if the customer has not paid yet. You record expenses when they are incurred — when the business receives the benefit, even if the bill has not been paid yet. It tracks what happened in the business.
The key difference is timing. Cash basis asks "when did the money move?" Accrual basis asks "when was the work done or the cost incurred?"
See It
Let's watch a small landscaping business through March. The same four events will be recorded two ways — once on cash basis and once on accrual basis. Watch how the timing changes the result.
March 3 — Cash sale: $500
A customer pays $500 the same day the lawn service is completed. Cash moved in March and the work was done in March.
Cash Basis
Record $500 revenue in March
Accrual Basis
Record $500 revenue in March
Both methods agree here — cash moved and work was done in the same month.
March 10 — Large job invoiced: $2,000 (paid in April)
A big landscaping job is completed on March 10. The customer is invoiced and will pay in April. No cash moved in March.
Cash Basis
No revenue in March — cash has not arrived
Accrual Basis
$2,000 revenue in March — the work was earned
Here the methods disagree. Cash basis waits for April. Accrual basis records March revenue and creates an Accounts Receivable for the unpaid invoice.
March 15 — Rent paid: $800
March rent of $800 is paid from the checking account on March 15.
Cash Basis
$800 expense in March
Accrual Basis
$800 expense in March
Both methods agree — cash was paid and the cost belongs to March.
March 20 — Supplier bill received: $600 (paid in April)
Materials used for March jobs arrive with a $600 bill due in April. No cash left the bank in March.
Cash Basis
No expense in March — cash has not left
Accrual Basis
$600 expense in March — materials were used
Cash basis waits for April. Accrual basis records the March expense and creates an Accounts Payable for the unpaid bill.
March Results Side by Side
| Line | Cash Basis | Accrual Basis |
|---|---|---|
| Revenue | $500 | $2,500 |
| Expenses | $800 | $1,400 |
| Profit | $(300) | $1,100 |
Same business. Same month. Cash basis shows a loss because the big invoice has not been collected yet. Accrual basis shows a profit because it counts the work that was actually done. The difference — $2,000 of earned but uncollected revenue and $600 of incurred but unpaid expense — sits in Accounts Receivable and Accounts Payable.
Why Profit and Bank Balance Are Different
New bookkeepers often expect profit to equal the change in the bank account. It rarely does. Profit measures what the business earned and spent during a period. The bank balance measures cash on hand right now.
If a customer owes you $2,000, that is profit on the books but not cash in the bank. If you paid six months of insurance upfront, that is cash gone from the bank but not all expense yet. The gap between profit and cash is filled by Accounts Receivable, Accounts Payable, prepaid assets, and unearned revenue.
This is also why the accounting equation matters so much. Revenue increases equity. Cash increases assets. When they happen at different times, the equation shows where the missing piece went.
Do It
Now it is your turn. Sort the same four March events into two worksheets — one for cash basis and one for accrual basis. Type each amount into the correct spot. Only include amounts that belong in March for that method.
Do It — Sort March's Activity
Below are four business events from March. For each one, type the amount into the correct column of each worksheet. Put revenue amounts in the Revenue row and expense amounts in the Expenses row. Only include amounts that belong in March for that method. If an event does not belong in March for a method, leave it blank.
Tip: Cash basis records when cash moves. Accrual basis records when work is earned or a cost is incurred.
Mar 3: Cash sale — lawn service completed and paid same day
Amount: $500 · Revenue
Mar 10: Large job completed — customer invoiced, pays in April
Amount: $2,000 · Revenue
Mar 15: March rent paid from checking account
Amount: $800 · Expense
Mar 20: Supplier bill received for materials used in March — paid in April
Amount: $600 · Expense
March — Cash Basis
Only money that moved in March
Revenue (type amounts that were received in March)
Expenses (type amounts that were paid in March)
March — Accrual Basis
What was earned and incurred in March
Revenue (type amounts earned in March)
Expenses (type amounts incurred in March)
Prove It
Answer each question, then read the explanation. There's no score — this is just to help the ideas stick.
Question 1
Under accrual basis, when should a business record revenue for work completed in March if the customer pays in April?
Question 2
A business pays $1,200 in January for insurance that covers January through March. Under accrual basis, what happens to the expense?
Question 3
Why can a business show a profit and still have a low bank balance?
Key Takeaways
- Cash basis records revenue when cash is received and expenses when cash is paid.
- Accrual basis records revenue when it is earned and expenses when they are incurred — regardless of when cash moves.
- Accounts Receivable holds earned but uncollected revenue. Accounts Payable holds incurred but unpaid expenses.
- The same business activity can produce different profit numbers depending on the method used.
- Profit and bank balance measure different things. The gap is filled by receivables, payables, prepaids, and unearned revenue.
- Accrual basis gives a more complete picture of what happened in the business during a period.