Cash vs Accrual Accounting Explained for Creative Business Owners

Welcome to the Creative Mind Smart Money Podcast where we turn financial confusion into creative confidence. I'm Samantha Eck, the keeper and fractional CFO for creative entrepreneurs. Each week I'm sharing my financial expertise and actionable strategies to help you build a thriving creative business. Plus you'll hear from industry experts who bring fresh perspectives on growing your business beyond the numbers. Because building a successful creative business starts with strong financial foundations. Your next chapter starts now. Welcome back to another episode of Creative Mind's Smart Money. And today's another topic I probably should have talked about a long time ago, but we're going to get into it anyways. It is cash versus a cruel accounting. And you're probably looking at me and saying, Samantha, that is way over my head. That is a finance term I've never understood. I don't get what you're talking about. You're crazy for you from bringing it up. But I promise you it'll make a whole lot more sense once we actually get into it. So it's one of the most confusing financial topics out there. And it's actually one of the most important if you actually want to trust your numbers. So when you make a 10k sale, but your report still say you lost money, you finally got paid, but your profit looks great before the cash hit. It's a lot of frustration that I've built from that. So I'm going to get into this today and help you make sense of what cash versus a cruel is using some real word examples. And then breaking down the pros and cons to help you choose what's right for your business stage. And kind of like, what's right for you right now. So right now, let's talk about what the difference is. So on a cash basis, it means that you recognize your income when cash hits the bank. So if I were to pay you today and two days later, the cash paid hits the bank, that is cash basis. You've recognized that income. It comes in and you recognize expenses when you actually pay them. So if you have, for example, you took something on your credit card, that expense is actually paid. So it's a simple rule, which means no money with me equals no entry. So for example, you invoice a client in June and they pay in July, it counts as July income. It's not June income, even though you invoice them in June. Your order prints in June, but you pay the bill in August, it counts in August. It doesn't count in June again. So those kind of like differences there. With a cruel basis, you recognize income when it's earned regardless of the payment timing. So you could get paid in July, but don't earn it until August. And then you also recognize expenses when they're incurred, even if they are paid later. So if you sent out an invoice in June, that's June income, even if you get paid in July. So that invoice will show up on your June income. If you order supplies in June, that is a June expense, even if you pay it in August, because you have something like accounts receivable accounts payable. So to give you a little bit more of like an analogy and kind of like how you can think about this is cash is what's happening in your wallet and a cruel is what's happening in your planner. So let's kind of come up with a visual example here. So let's say you invoice $5,000 in June. And money in a cruel example is going to come out in June. So on a cash basis, P and L, obviously if you get that money in July, it's going to count in July. But if it comes in in a cash in a cash basis, it's going to hit in June. Even if you're kind of pays you in July, it doesn't matter because that money is technically earned in June. And then for your software expenses, if you build in June, but you paid in July, as in a cruel basis, it's going to count in June, but a cash basis, it's going to count in July. So when we think about this, when we look at this June income for a cash basis, P and L, it's going to be zero incomes, your expenses, your profit, whereas a cruel basis is going to be $5,000 income, $200, $200 expense, $4,800 profit. And then July again, $0,000. So again, the point is that the cash basis is going to tell you what's in your account, but not necessarily what you're actually making. The a cruel basis tells you what you earned. And oh, even if it hasn't moved yet, even if the money's kind of still sitting there, I know that sounds confusing. So we're really going to go into this a little bit more and talk about it so that you can get more of a visibility and understanding of it. So let's talk about the pros and cons between the two of them. And let's start with a cash basis. So first of all, it's simple to understand and truck. And actually a lot of my clients use cash basis when they're very, very small. It matches your bank account to show you what's actually there. And obviously it's easier for small businesses with a really, really tight cash flow. But it can look misleading, like your broker when you're not or profitable when you're overdrawn. It doesn't match when work is done versus when paid. And it can hide really big issues for example, like a lot of lots of unpaid invoices, things like that. It can just cause a lot of really big issues. For the a cruel basis, it gives you a clear picture of your performance over time. So we're matching income and expenses to when they actually happen, which helps with forecasting goal tracking. And of course, decision making. It does make it a little bit more complex because if it doesn't match your bank balance, you might look profitable, but you could have zero dollars in cash. And then of course, with a cruel, a cruel is where you really kind of need that bookkeeping, that bookkeeping help because a cruel can he becomes a lot more. I guess interesting. There's a lot of different journals and things like that that need to be set up with a cruel accounting. Most small businesses can use cash basis for tax filing if they're under $25 million in revenue. So actually most of the businesses that I work with use cash basis because it's just that much easier. They don't need a cruel and they don't have accounts for saleable and payable. They don't pay on terms. They don't process on terms. They just want to get the money when it hits our accounts. If you carry inventory, you might be required to use a cruel basis accounting. So you'll have to look into kind of like the rules around that because it's different per state. It's also different depending on what you're selling. A cruel becomes required if you grow or large enough. So it's good to understand it really early and get just a clear understanding of what's going on with them. So what do I recommend as ACFL and bookkeeper? If you're early stage, you're very small, you're very cash conscious. I really do recommend doing cash basis deviled starting point and as long as you know what it's not telling you it's it works. I recommend though a cruel if you really want scaling an insight and you don't just want to go with the off of what's just in your big mouth. Like if you want to understand it a little bit more, then I definitely recommend a cruel basis and it's going to help you to just again have that forecast, have that profitability analysis, everything like that. It's going to be a lot easier when you have numbers that actually reflect in the months that they occurred instead of months later. So I want you to understand as well that one isn't better than the other. A cruel accounting isn't better than cash accounting. Of course, it's about what you need your numbers to do for you. So you can run on cash accounting if you're under 25 million. Like if you have a business that you're only making 250k a year, you're happy with that. You're like, I don't want to ever switch. Don't. But if you're like, I really need more clarity insight and understanding in numbers, then switching to a cruel isn't a bad option. If you aren't sure what you're currently using or if you should switch, just again, message me on Instagram to me, email whatever it is and let's kind of talk about what it is that you're currently doing and how we can transition if you want to. As always, if you find this episode helpful, please leave a comment, like it, subscribe. And of course, share it on social media so that we can get more people like you to listen to the podcast. Otherwise, you guys, I wish you the best week ever and we'll see you next week. Farewell, fellow travelers.