Accrual basis

The difference in one example

Suppose work is completed in March, invoiced in March, and paid in May. On a cash basis nothing happened in March and everything happened in May. On an accrual basis the income belongs to March, when the work was done, and May records only the settlement of a debt that already existed.

The same split applies to costs. Materials delivered in March and paid for in June are a March cost under accrual recording and a June cost under cash recording. Over a long enough span the two bases converge, because everything is eventually paid. Over any single period they can differ enormously.

Why the distinction matters

The purpose of dividing a business into periods is to judge how it performed in each. Cash recording makes that judgement unreliable whenever there is a delay between doing something and being paid for it, because a good month with slow customers looks worse than a poor month with fast ones. Accrual recording removes that distortion by matching effort to reward within the same window.

The price of that accuracy is that the accounts stop describing the bank. A business on an accrual basis can report a profitable period while running short of money, and this is the ordinary reason a growing small business feels poorer as it succeeds: growth consumes cash before it produces it.