In the world of accounting there are two ways to track your finances and update your accounting records: cash accounting and accrual accounting. Let’s dive into the difference between the two approaches and why it makes sense to start with cash and then get to accrual.

What is accounting?

Simply, accounting is the process of recording what has happened in the business from a financial perspective. This is inherently different than finance which is focused more on the why things happened and how to plan for the future. Accounting is solely focused on the past and in categorizing the things that have occured.

What is cash accounting?

Cash accounting is the process of keeping your accounting records based off of when you spend the cash or receive the cash in the business. For example, if I provide a service for a year and get paid $100,000 on January 1st, in cash based accounting, I would have revenue / income of $100,000 on January 1st.

For food and beverage businesses this is incredibly impactful for items like purchasing inventory. In a certain month, if I purchase $300,000 of inventory, I will have a $300,000 expense for that month. As a result, unless I really crush sales, it can be really difficult to show that the month was profitable, even if it is a record setting sales month.

What is accrual accounting?

Accrual accounting is the process of keeping your accounting records based off of when the related service or product is actually used or earned. For example, if I provide a service for a year, even if I get paid $100,000 on January 1st, I worked on it every month. Rather than saying I made $100,000 in January, I would show that I made $100,000 / 12 = $8,333 each month.

For food and beverage businesses this typically is most impactful in the Cost of Goods side of the business. In the earlier example, when I buy $300,000 of inventory, rather than saying that I had an expense of $300,000, I would say that I have inventory of $300,000 and the only expense would be when I sell the product. So, if I sell 1/4 of that $300,000 of inventory in January, then I recognize $75,000 of expenses instead of the full $300,000.

When should I do each?

Simply — cash accounting is best when you first get started. Accrual can be pretty complex and difficult and until you’re at a place when you are sure it’s worth the efforts, it can be avoided. Generally, I advise the switch to accrual when a company is doing ~$1 million in sales in a year OR when they are purchasing large quantities of inventory and need to be certain that they are making money.

It can be critical when trying to get financing from banks to show consistent profitability. When you are in a cash accounting process, those months of large purchases can be quite difficult to show that profitability.