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Cash-Basis vs Accrual-Basis Accounting

You might have learned the terms Cash-Basis and Accrual-Basis on various occasions and might be wondering what those terms mean and how the two accounting treatments affect businesses and decision-making. Below is the summary of the definitions, applications, and key pros and cons of both methods.

Cash-Bases

The most straightforward advantage of the cash-basis approach is its simplicity. In this treatment, the revenue is recognized when the cash is collected, and expenses are recognized when the cash is paid. Under the cash basis, there is no need to account for customer sales made on credit (i.e. accounts receivable) until they pay. Similarly, no bookkeeping is required for purchases from vendors on credit (i.e. accounts payable or accrued expenses) until the company pays for them. Cash-basis accounting is a simple way to easily see a company’s cash status. Many businesses prefer to use cash accounting because the financial statements closely reflect their cash position, which is especially important for small business owners. The simplicity also makes bookkeeping easier and cheaper. And under cash-basis accounting, a business doesn’t have to pay taxes on cash it hasn’t collected.

The main disadvantage of the Cash-Basis is that financial reports may not represent reality at a given point. For example, a business may make a sale in 2019 but expects to be paid for it only in 2020.

In this case, the revenue is recorded in 2020 when the transfer of the ownership of the assets occurred in 2019. This would distort the picture as in 2019 company would report no sales. Another disadvantage is that Cash accounting mostly follows a single-entry system while Accrual accounting follows a double-entry system. Another limitation is that under IRS rules Businesses with more than $25 million in gross revenues can not run the books on Cash-Basis, hence, the method is limited to small businesses.

Accrual-Basis

The Accrual method is considered to better match revenues and expenses and standardizes reporting information for comparability purposes. Accrual accounting bookkeeping is uncoupled from when the money involved actually changes hands, thereby smoothing the impact of timing and yielding a more accurate overall picture of business’ operations. Rooted in the concept of the matching principle, where revenues and expenses are recognized in the period in which the transaction occurs and not when cash exchanges hands, accrual basis accounting provides more timely insights for analysts and investors.

However, accrual basis accounting relies on estimates and assumptions from management, providing management with the opportunity to manipulate the appearance of its financial performance. The accrual component of a company’s earnings is commonly less persistent over time. When making comparisons of companies, generally those with a higher proportion of accrual-based earnings are considered to have weaker earnings than those with a higher proportion of cash flow-based earnings. Another disadvantage of accrual accounting is the additional bookkeeping. Rather than just looking at cash coming in and out, businesses using accrual accounting monitor receivables, prepaid expenses, accounts payable, and other accrued liabilities. It also requires more frequent closing of the company’s books. Another disadvantage is that the accrual basis might obscure short-term cash flow issues in a company that looks profitable on paper.

Conclusion

The accrual basis of accounting is the gold standard because it gives a more accurate representation of a company’s finances. Cash-basis accounting might be right for your business if you rely on cash payments for revenue and expenses. Conversely, businesses that extend credit to customers or use credit with their suppliers tend to find that accrual accounting gives a better picture of overall financial health. Businesses that hold large amounts of inventory also benefit from accrual accounting. In general, the greater the lag in conversion to cash from sales, the stronger the argument for accrual-based accounting.

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Narek
Narek Abgaryan
Narek is the CEO of Hundred MS. Before embarking upon this position, he accumulated insightful experience including the positions of CEO, Head of Research and Member of the Board at various licensed and regulated investment companies. Narek is a graduate of Hult International Business School, Armenian State University of Economics and is currently pursuing his education at Saïd Business School of the University of Oxford. Narek is a CFA charter holder and a certified FRM.
CFA, FRM
Corporate Finance Investment Performance Management
Narek Abgaryan
Narek is the CEO of Hundred MS. Before embarking upon this position, he accumulated insightful experience including the positions of CEO, Head of Research and Member of the Board at various licensed and regulated investment companies. Narek is a graduate of Hult International Business School, Armenian State University of Economics and is currently pursuing his education at Saïd Business School of the University of Oxford. Narek is a CFA charter holder and a certified FRM.
CFA, FRM
Corporate Finance Investment Performance Management
Our Mission
Our mission is to extend our partner-based, specialized and cost-effective cooperation to our clients to enable them to focus on their long-term strategy and leverage their core competencies around value-creating activities.
Our Mission
Our mission is to extend our partner-based, specialized and cost-effective cooperation to our clients to enable them to focus on their long-term strategy and leverage their core competencies around value-creating activities.
Our Vision
We have a deep conviction that the financial system is the pillar of our civilizations. Economies that are exploding with growth are the ones that adopted modern finance. We aim to reach a reality where access to unconventional finance technics should be within reach of every economic unit. This shall empower everyone to allocate their human and financial capital more purposefully and innovatively for the benefit of a secure, wealthy, and responsible society.
Our Vision
We have a deep conviction that the financial system is the pillar of our civilizations. Economies that are exploding with growth are the ones that adopted modern finance. We aim to reach a reality where access to unconventional finance technics should be within reach of every economic unit. This shall empower everyone to allocate their human and financial capital more purposefully and innovatively for the benefit of a secure, wealthy, and responsible society.
Objectives
In "Hundred MS", we are structuring our goals to revolve around the best interests of our investors and business partners. The basis we build our strategy on is satisfaction of expectations of our Clients, by bringing substantial profits to them through ethical management of investments, assets and portfolios. In the path of achieving the set tasks, we target new financial products adapted to the Client’s needs and offer variety combinations of interdisciplinary innovations. Following our set of values, we see our short-term goal in becoming one of the leading players in the global financial markets.
Objectives
In "Hundred MS", we are structuring our goals to revolve around the best interests of our investors and business partners. The basis we build our strategy on is satisfaction of expectations of our Clients, by bringing substantial profits to them through ethical management of investments, assets and portfolios. In the path of achieving the set tasks, we target new financial products adapted to the Client’s needs and offer variety combinations of interdisciplinary innovations. Following our set of values, we see our short-term goal in becoming one of the leading players in the global financial markets.
Corporate Values
We believe that earning the trust of each Client cements the next layer of the foundation of the Company’s reputation. Financial relations are built on trust; thus, our reputation is the heart of our business. Our allocentric approach to dealing with clients ensures that we always put their interests first. We do our utmost to make sure that our decisions are utterly disconnected from the greed when it comes to rendering our services. Promulgating ethics and adhering to the highest professional standards are the bedrocks of our corporate values.
Corporate Values
We believe that earning the trust of each Client cements the next layer of the foundation of the Company’s reputation. Financial relations are built on trust; thus, our reputation is the heart of our business. Our allocentric approach to dealing with clients ensures that we always put their interests first. We do our utmost to make sure that our decisions are utterly disconnected from the greed when it comes to rendering our services. Promulgating ethics and adhering to the highest professional standards are the bedrocks of our corporate values.
Levon
Levon Garibyan
Levon is the Business Development Director and Strategy Specialist of the company. He acquired international experience of more than 10 years, managing private firms with various business profiles in UK, UAE and Russian Federation. Levon studied in Cranfield University School of Management and Moscow State University of International Affairs (MGIMO).
MSc
Business Development, Strategy & Fundraising
Levon Garibyan
Levon is the Business Development Director and Strategy Specialist of the company. He acquired international experience of more than 10 years, managing private firms with various business profiles in UK, UAE and Russian Federation. Levon studied in Cranfield University School of Management and Moscow State University of International Affairs (MGIMO).
MSc
Business Development, Strategy & Fundraising
David
David Tarkhanyan
David is the co-founder of Hundred MS. He is a Banking specialist with a focus on Financial Controlling, Planning, and Performance Management. His experience extends more than 10 years in various investment banks in Vienna and Frankfurt. David studied Physics at Bauman University and Industrial Engineering at the American University of Armenia.
CFA, FRM
Financial Controlling Investment Banking
David Tarkhanyan
David is the co-founder of Hundred MS. He is a Banking specialist with a focus on Financial Controlling, Planning, and Performance Management. His experience extends more than 10 years in various investment banks in Vienna and Frankfurt. David studied Physics at Bauman University and Industrial Engineering at the American University of Armenia.
CFA, FRM
Financial Controlling Investment Banking