Accrual or cash: which method your books actually use

The two methods differ on exactly one question: on what date does a transaction enter the books?

Under cash accounting, the date money moves. You sold something in March and were paid in May, so it is May revenue. You received a repair bill in March and paid it in April, so it is an April expense. The books are, in effect, an annotated bank statement.

Under accrual accounting, the date the transaction happens economically. The March sale is March revenue because that is when you earned it by delivering. The March repair bill is a March expense because that is when the work was done and the obligation arose. Whether money has moved is recorded separately, as a receivable or a payable, and the payment later settles that balance instead of creating new revenue or expense.

Everything else follows from this one difference. Accrual needs the extra machinery of receivables and payables, because a sale recorded before payment has to be tracked somewhere until it is collected. Cash needs none of that, which is why it is simpler, and the simplicity is bought by not knowing certain things. Both methods eventually report the same totals over the life of a business. They differ on which period each amount lands in, and businesses are managed and taxed by period.

Take a month in which you invoice four hundred thousand rupees of work, collect two hundred thousand from earlier invoices, receive supplier bills of one hundred thousand, and pay one hundred and fifty thousand of older bills.

Cash accounting reports revenue of two hundred thousand and expenses of one hundred and fifty thousand, so a profit of fifty thousand. Accrual accounting reports revenue of four hundred thousand and expenses of one hundred thousand, so a profit of three hundred thousand. The same month, the same events, one figure six times the other.

Neither is wrong. The cash figure describes what happened to your money. The accrual figure describes what your trading activity was worth. If you are deciding whether the month's work was profitable, the accrual number answers it, because the cash number is dominated by the timing of collections from months you are not asking about. If you are deciding whether you can afford to buy something next week, the cash view is the relevant one.

This is why the argument is not about which method is correct. A business running purely on cash accounting can have its best trading month recorded as a loss because two large customers happened to pay late, and can then make decisions based on that loss. The distortion is not an accounting curiosity; it changes what people do.

Many small businesses are unsure, and the answer usually is: accrual in the annual accounts, cash in the owner's head, with a gap between them nobody has looked at.

The test is simple. Look at whether your books contain a figure for money customers owe you and a figure for money you owe suppliers, maintained continuously rather than assembled once a year. If they do, the books are on accrual, because those balances only exist to hold transactions recorded before the money moved. If the records are essentially a categorised bank statement with no such balances, they are on cash.

A common intermediate state is worth naming because it is the most misleading. Records are kept on a cash basis through the year and then adjusted at year end by the accountant, who adds the unpaid invoices and unpaid bills to produce accrual accounts for filing. The filed accounts are accrual. Every monthly figure the owner saw during the year was cash. So the year-end profit can differ substantially from the sum of the months, and the difference arrives as a surprise, sometimes as a tax liability on profit that was never visible.

In India there is a further reason accrual concepts intrude regardless of preference: GST liability is generally tied to the time of supply, so what you owe can arise from invoicing rather than from collection.

Cash accounting hides obligations and entitlements. A business with a drawer of unpaid supplier bills looks profitable under cash accounting precisely because it has not paid them, and the books contain no signal that a large payment is owed. It equally cannot see money owed to it, so it has no way of knowing whether receivables are growing, which is one of the earliest warnings of trouble. And because it records on payment, it can be shaped: delay a supplier payment past the year end and the expense moves to next year.

Accrual accounting hides cash. Revenue is counted at invoicing whether or not it will ever arrive, so a profitable statement is compatible with an empty bank account. It also relies on estimates. Whether a doubtful receivable should be provided for, how stock is valued, and what depreciation rate applies are judgements that change the profit figure, and none of them is verifiable the way a bank statement is.

The conclusion most practitioners reach is that you need both views and they answer different questions. Accrual for whether the business works, cash for whether it survives the month. This is exactly why a cash flow statement exists alongside a profit-and-loss statement rather than instead of it, and why looking at only one of them is the underlying cause of most surprises.

Method choice in India is not purely a management preference, and the detail is genuinely a professional question rather than something to settle from an article.

In broad terms, the Income-tax Act contemplates income being computed under either the cash or mercantile system for business income, with the method to be followed regularly, while companies are subject to accounting standards and the Companies Act that effectively require accrual. There are also presumptive taxation schemes under which income is computed as a prescribed proportion of turnover, which changes the question considerably for the businesses eligible for them, and separate provisions on how specific items must be treated regardless of the general method.

GST works on its own timing rules. Liability generally attaches by reference to the time of supply, which is determined by dates including the date of invoice, rather than by when you are paid, and there is a separate composition scheme with its own basis. The practical consequence is that a business keeping cash-basis records can still owe GST on invoices raised and not collected.

The eligibility conditions, thresholds and turnover limits attached to all of these have been amended repeatedly and continue to be. Anything specific here, including the outline above, is a description of the shape rather than the current numbers. What method applies to you, and what you are permitted to change to, depends on your constitution, turnover, registration and history, and is a question for your accountant with your figures in front of them.

Choosing a method decides which period a transaction appears in. It decides nothing about whether the underlying facts are right, and the method is often blamed for problems that belong to the records.

Neither basis tells you whether an invoice will be paid. Accrual counts it as revenue and cash simply waits, and neither contains an opinion about the customer. Neither tells you whether stock on hand is worth what it cost. Neither knows about a commitment made verbally, a dispute that is about to reduce an invoice, or a customer whose business is failing. These are facts about the world, and the books can only hold them once a person has decided what they are and recorded it.

The practical implication is where effort should go. Switching method, or producing a second set of figures on the other basis, is worth doing when it answers a question you actually have. It is not worth doing in the hope that it will make the numbers more true, because both methods are equally dependent on transactions being captured completely, invoices being raised for everything supplied, and estimates being made honestly. A well-kept cash-basis book is more useful than a badly kept accrual one, and any bookkeeping system can enforce consistency of method while remaining entirely unable to tell you that a receivable has gone bad.