Cash vs Accrual Accounting: Which Is Right for Your Business
If you have started looking into accounting software or spoken to an accountant about how your books should be set up, you have probably come across the terms cash accounting and accrual accounting. These describe two different ways of recording when income and expenses actually count in your books, and the choice between them can genuinely change how your numbers look.
Cash Accounting Explained
Under cash accounting, income is recorded when you actually receive the money, and expenses are recorded when you actually pay them. If you send an invoice in March but the customer does not pay until May, that income counts in May under cash accounting, not March.
This method is simple and tends to closely reflect what is actually happening in your bank account. Many sole traders and very small businesses use cash accounting because it is straightforward to understand and manage.
Accrual Accounting Explained
Under accrual accounting, income is recorded when it is earned, regardless of when the money actually arrives. Using the same example, an invoice sent in March would count as March income under accrual accounting, even though the cash does not land until May. The same applies to expenses, which are recorded when they are incurred, not necessarily when they are paid.
This method gives a more accurate picture of how the business performed during a specific period, since it matches income and expenses to when the related work or activity actually happened, rather than when cash happened to move.
Why This Matters for GST
In New Zealand, your GST registration also generally involves choosing between the cash basis or invoice basis, which mirrors this same distinction. Under the invoice basis, GST is accounted for when an invoice is issued or received, regardless of payment timing. Under the cash basis, GST is only accounted for once payment is actually made or received. This is a separate decision from your overall accounting method, but the two are closely related and worth discussing with your accountant when you register for GST.
Which One Should You Use
Cash accounting tends to suit smaller businesses, sole traders, and businesses where most transactions are paid close to when they happen. It is simpler to manage and closely tracks your actual bank balance.
Accrual accounting tends to suit larger businesses, businesses that regularly invoice on payment terms, or those holding stock, since it gives a more accurate view of profitability during a specific period rather than being skewed by payment timing.
There is no universally correct choice. It depends on the size and nature of your business, and sometimes there are tax related thresholds and rules around which methods are available to you, so this is worth confirming with your accountant.
Whichever method your business uses, the most important thing is that your books are set up consistently and correctly to match it. If you are not sure which method your business is currently using, or whether it is the right one, that is a good question to bring to your next conversation with your bookkeeper or accountant.
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