This is a concept that mystifies many non-finance types, but it’s actually quite simple. The difference between cash versus accrual reporting is simply timing. A transaction has two dates; a cash date and an accrual date. They can be the same or different. Let me explain.
If you pay for something via a bank transfer or debit card on the day you made the purchase, let’s say some tea, coffee and snacks at the supermarket for your office, the cash and accrual reporting date will be the same. You can verify this by looking at the date on your tax invoice or receipt and by looking at the payment date on your bank statement. In this situation, both dates are the same, and therefore, the date you committed to buying something (accrual reporting date) was the same date you paid for it (cash reporting date).
Another way to think about this is when your business has a supplier that it buys from on credit. These terms might be seven days, 14 days, 30 days or even 30 days after end of month. The date on the supplier invoice is the accrual reporting date. The date you pay your supplier for any given invoice is the cash reporting date for that same transaction.
This applies the same way to a sale as it does to a purchase. When you sell to a customer and they don’t pay you on the same date, the accrual and cash dates will be different. The date of the invoice is the accrual reporting date, and the date of the payment is the cash reporting date.
And this is where people can struggle to understand why their business is showing a profit but doesn’t have as much cash in their bank account as they’re expecting. There are many reasons for this, but one basic reason may be that they’ve made a sale, that is appearing on their profit and loss statement, contributing to both income and profit, but certain customers haven’t paid them yet. To know how much this is impacting your bank account you need to look at your balance sheet report. The accounts receivable balance on your balance sheet will tell you how much you’ve invoiced your customers but not been paid for on a given date. Your bank account deposits will need to be reconciled up to that date in order for this figure to be accurate.
On the flip side, your bank account may look better than the profit and loss report suggests. Again, there are many reasons, but if you collect cash at the time of the sale, but have credit terms with your suppliers, you’ll see the same situation in reverse as the one described above. To work out how much this is impacting your bank account, you need to look at the balance sheet report. The accounts payable balance will tell you how much you’ve been charged by your suppliers but have not paid for on a given date. Your bank account withdrawals will need to be reconciled up to that date in order for this figure to be accurate.
However, there’s a caveat here. If you aren’t entering your purchases with accrual reporting dates (when the supplier issues you an invoice), but rather reconciling bank withdrawals directly to expense accounts rather than reconciling withdrawals to accounts payable transactions (cash-only reporting), you will never be able to see the difference between cash versus accruals. To monitor your accounts payable balance, you need to enter accounts payable transactions (supplier invoices). The same applies to sales. Most businesses issuing sales invoices that aren’t paid same day run an accounts receivable balance. It’s how they stay on top of which customers owe them money.
For some businesses, reconciling expenses on a cash-only reporting basis after something has been paid for is fine. But if you want to do some analysis, entering purchases one-by-one and managing an accounts payable balance is essential. It helps you know the profitability and position of your business far more accurately and also helps you plan for future cash outflows. It sums up to less flying by the seat of your pants and having more control.
So how else does this impact you? If you’re running a business in Australia, most likely you’re registered for GST and lodging monthly or quarterly activity statements for GST. If you’re reporting GST on a cash basis, the date you pay expenses or receive income are the dates used to calculate what GST you owe the ATO (or the ATO owes you). If you’re reporting GST on an accruals basis, the dates you record your commitment to pay for expenses via accounts payable invoices and receive income via accounts receivable invoices are the dates that will be used to calculate the figures on your activity statement.
Your tax return is usually completed on an accrual reporting basis. It’s rare to report a tax return on a cash basis. This means that the amount of income tax you owe will be calculated on the date income and expenses were committed to, rather than the dates they were collected and paid.
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