What Is the Difference Between Accrual Basis and Cash Basis Accounting?

This is the second topic within "The Basics” section of the Finance 101 for Lawyers series which discusses the difference between Accrual Basis Accounting and Cash Basis Accounting. 

  • Under the standards of Accrual Basis Accounting, a company’s revenues are recorded when earned, which may or may not be the same time the company receives payment.  Similarly, expenses are recorded when the expense is incurred, which may or may not be the same time as when the company makes a payment for that expense.
  • Under the standards of Cash Basis Accounting, the revenues are recorded when the cash payment is received by the company, which may or may not have been the same time as when the company delivered its product or service to its customer.  Expenses are also only recorded when the expense is paid, which, again, may or may not be when the actual expense was incurred.

A Simple Example: Selling a Product and Sending an Invoice to the Customer

It is common for a company to sell a product or provide a service to a customer and follow up with an invoice that the customer is supposed to pay later (i.e., net 30 days).  Although there are specific revenue recognition rules, in general, Accrual Basis Accounting recognizes revenue when the product is received by the customer.  The company then sends an invoice to the customer asking for payment.  No cash has yet been paid by the customer, but the revenue is recognized on an Accrual Basis.  When the customer eventually pays the invoice (i.e., in 30 days), there is no impact on revenue in an Accrual Basis system because that revenue has already been recognized. 

Under Cash Basis Accounting, revenue is only recognized when the customer eventually pays for the product and not before.  In the example above, the company ships the product to the customer and the customer receives the product.  No revenue is recognized at this step.  Only once the customer pays the subsequent invoice and the payment is received by the company is revenue recognized and recorded under a Cash Basis system.

The Difference Is More Than Just Timing

It may seem like the only difference between Cash and Accrual Accounting is a matter of timing – when the revenue gets recognized in the example above.  There is more to it than that. 

For example, under an Accrual Basis Accounting system, the company has delivered the product and has not yet been paid.  To accurately present its true financial position, the company needs to provide information on the money it is owed by its customers for goods or services already delivered (accounts receivable).  Conversely, under Accrual Accounting the company must also record and present information on the amounts it may owe its suppliers and vendors for goods and services the company has received but not paid for yet (accounts payable).

Why Use Accrual Basis Accounting?

In the U.S., Accrual Basis Accounting is required for the presentation of financial information for publicly traded companies and is commonly used by other midsize private companies.  Generally Accepted Accounting Principles (GAAP) also typically requires Accrual Basis Accounting.

The theory is that Accrual financial information provides a more complete picture of the financial position of a subject company.  For example, by clearly identifying amounts owed by customers and amounts owed to vendors, a person reading a financial statement will have a better ability to assess the relative financial health of a company.

Why Use Cash Basis Accounting?

Cash Basis Accounting information is sometimes considered easier to track.  For example, most of us use Cash Basis Accounting principles in our personal lives as we manage our personal finances when balancing our check book and/or tracking the cash balance in our bank accounts. 

Smaller companies and professional service firms may only prepare Cash Basis Accounting statements, or they may prepare a hybrid referred to as Modified Cash Basis Accounting.  For example, most law firms prepare their internal financial statements on a Cash Basis, but also track their accounts receivable (bills sent to clients, but not yet paid).  Accounts receivable is an Accrual Accounting concept, but an important financial statistic for a law firm to manage even if it prepares primarily Cash Basis financial reports.

How Can You Tell What Is Being Shown in Financial Information Provided?

Most financial statements will say whether they are being presented on an Accrual or Cash Basis.  The notes that accompany reviewed or audited financial statements will clearly state the basis of presentation.  Most software that companies use to prepare their internal financial statements can present both Accrual and Cash Basis statements.  Therefore, the common software applications will often state in the header of each report which basis of presentation is being used for that specific presentation.

Even if it is not labelled, there are obvious clues.  If on the Balance Sheet there are items associated with Accrual Accounting, the statements are presented on an Accrual Basis (or a hybrid Modified Cash Basis).  The Accrual associated accounts include accounts receivable, accounts payable, prepaid expenses, and deferred revenue, among others.


It is important to understand the difference between Accrual and Cash Basis Accounting before attempting to interpret financial information and financial statements.  Accrual Basis Accounting recognizes revenues and expenses when they are incurred, which may be a different point in time from when the cash might actually change hands.  For that reason, in Accrual Accounting it is necessary to track things like accounts receivable (outstanding invoices to customers) and accounts payable (outstanding invoices from vendors).  Accrual Accounting is required for the public companies in the U.S. and is common among midsize and larger companies.  Cash Basis Accounting, conversely, records transactions only when the cash changes hands.  It is sometimes considered more simplistic and commonly used by smaller firms and firms in certain industries (i.e., professional service firms).  To appropriately interpret accounting or financial information, the reader should understand the basis upon which that information was prepared.


About the Series 

Finance 101 for Lawyers is an ongoing educational series of professional insights intended to explain core accounting, finance, and business valuation concepts to lawyers.  The series is designed to provide an overview of these topics to assist lawyers as they counsel their clients on financial issues and present financial information to judges and juries. 

Note that the discussion represents an overview of certain financial concepts.  As with any summary, certain nuances and complications are not addressed in detail.  Appropriate financial analysis should consider the specific facts and circumstances of each situation.

About the Author

Brian Dies, CFA, ASA is a Principal at Archway Research and is an expert in the financial analysis of complex transactions, business valuations, and damages in commercial disputes.  Mr. Dies holds the Chartered Financial Analyst designation and is also an Accredited Senior Appraiser in the Business Valuation discipline with a specialty designation in Intangible Asset Valuation.  Mr. Dies has also spent time as an Instructor at the Harvard University Extension School teaching Business Valuation at the graduate level.