In QuickBooks® difference between Cash Vs Accrual Accounting. In QuickBooks® there are 2 main methods of accounting that your business can use to report income and expenses:
- Cash Basis
- Accrual Basis
The main difference between both methods is a bit like delayed gratification. Cash Method is when you delay your gratification when you have received the payment from your customer. The accrual method is when you want to book the revenue now!
With a cash basis, revenue is booked when it has been collected and expenses are booked when they are paid out.
With an accrual basis, you would book the revenue when it is earned and expenses when consumed but not yet paid out.
What is cash-based accounting?
In Cash accounting, the expenses and revenue are recorded as they are paid. If you sell a widget in March but are paid in May then you book the revenue for May. Similarly, when you receive the goods in June but make the payment to your vendor in August, the expense is booked in August.
Cash-based accounting reports do not include the sales that are unrealized and expenses that have not yet been paid to vendors. When the financial report is pulled in QuickBooks® it will look smaller than expected.
What is Accrual based accounting?
In Accrual accounting the expenses and revenue are recorded as they are incurred or earned. If you sell a widget in March but do not record the revenue until May, that revenue is booked for March ie when you earned it, and not when you got paid. You book the expense for the month when you received the goods or services. If you receive a bill from your CPA for $25,000 in April but you make the payment in May, the expense is booked April, when the service was delivered and not when it was paid.
Accrual based accounting reports in QuickBooks® usually look larger than actual. This is due to the revenue and expenses being included that have not yet been paid.
Which option should you use?
A cash basis is easier to understand and is the most time-efficient option for startups and small businesses like a sole proprietor, LLCs. This way you know your actual profitability metrics at all times. Before, the rules were that if you averaged more than $5 million in gross receipts over the prior three years, you were REQUIRED to file your taxes as an accrual basis taxpayer. But if you were an inventory-based business, that threshold dropped down to $1 million. Most remote bookkeeping companies will default to the cash basis accounting as it is the cheapest and most optimized method.
But as per the Tax Cuts and Jobs Act (TCJA), the limit has been increased to $25 million. Here is the guidance from the IRS.
This frees up even larger businesses that hold inventory in the E-Commerce and wholesale space to deduct the cost of goods as soon as they delivered and paid.
Accrual basis is a better choice for corporations, startups that have gained traction, and are looking for outside investors. Potential VC and accredited investors will generally insist on GAAP based financial reports. Accrual based accounting is the first step to get to GAAP based accounting.
Keep in mind though, Accrual basis accounting requires more effort to set up and careful bookkeeping practices to maintain every month by your virtual bookkeeping company so it will expensive vs. cash basis.
QuickBooks® Online Reporting:
When setting up QuickBooks® Online, it defaults to Accrual based accounting. In each report you can go to customize and toggle the financial report basis as per the picture below:
You can change the default basis with these steps below. If you have been in business for over a year then check with your bookkeeping company or your CPA before changing the accounting method from cash to accrual and vice versa.
Change the accounting method for your company in QuickBooks® Online.
- Select Settings ⚙, and then select Account and Settings.
- Go to the Advanced
- In the Accounting section, select the Edit ✎ icon.
- Choose the Accounting method.
- Select Save, then Done.
It is critical for your business to have accurate reporting of revenue and expenses.
If you are unsure of what method to use, you can reach out to your QuickBooks® Certified Advisor, your bookkeeping service, or your accountant and they should be able to guide you based on your goals and current state of books.