There are two accounting methods, which determine how a company’s transactions are recorded on its books- cash-basis accounting and accrual accounting.  The primary difference between the accounting methods hinges on how a business records incoming and outgoing cash.

Cash

Using the cash-basis, a company records its expenses when cash is paid out.  Likewise, revenue is recorded when the company receives a payment.  For example, if an artist finishes a commissioned piece of work in May, and doesn’t receive payment for the piece until June, the income is recorded on the books in June, upon receipt of payment.

In using the cash method, expenses and revenues are not matched precisely on a month-to-month basis. For example, until cash is paid out, expenses are not recognized. Likewise, revenues earned in previous periods aren’t recognized until cash is received. The cash method is great for tracking a company’s cash availability.

Accrual

Using the accrual method, a company records revenue upon earning it, even if a client hasn’t paid, yet. For example, if an artist finishes a commissioned piece in May, the revenue for the piece is earned in May, upon completion of the piece, even if the client hasn’t paid for the piece.

Similarly, using the accrual method, a company records expenses when they’re incurred–not when they’re paid out. For example, if an artist purchases art supplies, he may do so on account and will not pay out cash for the art supplies, immediately.  Regardless, the expense is recorded on the books when the transaction occurs.

In using the accrual method, expenses and revenues are matched, which provides a company a better understanding of its monthly expenses and profit. Expenses are recorded as incurred, regardless of when cash is paid out. Revenues are recorded upon project completion rather than when cash is received from a client.