Lessons

Lesson Info

Cash vs. Accrual Accounting

So this is great this is your basis this is what we're going to start with that's what we're going to use for the rest of this class um let's get into the real meat here I want to talk about cash versus accrual accounting this is we're going to start throwing jargon at you I'm not really gonna throw a lot of jargon you, but in the beginning we had a couple of words we have to cover. These are two of them so there to sort of general methods to accounting there's cash which records when payments come in or go out that's either payments that you make to someone else or payments that someone else makes to you as soon as the money hits your desk as it were a soon as it arrives in the mail uh that's cash a cruel records when bills go out or come in and again that's either bills you send to somebody else or bills that somebody sends to you. So if I, um if I do a hand painted sign for someone under the cash method, I don't record that as being paid until I've actually gotten the check from the...

m under the cash method under the accrual method as soon as you finish that sign and you've handed them the bill handed them the invoice that's when you recorded as income um similarly, uh if I mean, most bills get paid right on time these days but uh let's say that you hired that web designer finally um and they made a wonderful website for you um under the uh, cruel method as soon as you get that bill from them that's when you put it in as an expense under the cash method you don't enter it into your ledger until you've actually wrote the check and put it in the mail does that make sense so far cash versus a cruel okay so um what I really want to get across about that is that profitability and cash are not the same thing boring sample let's say you've sold three thousand dollars worth of products this month you've gotten five hundred dollars in payments so far still waiting on twenty, five hundred of that and you've spent two thousand dollars on supplies um your business made a profit you spent two thousand you made three thousand rights you've made a thousand dollars profit but you've got no cash available because you've only gotten five hundred dollars back in so far so under the cash method you had record that you had negative fifteen hundred dollars in income under the accrual method you've got positive a thousand dollars in income sam make sense so far and you can feel free to interrupt me with questions as they come in as well um on the other hand, let's say you've sold on ly a thousand dollars worth of products you've spent two thousand on supplies and in order to cover that you've invested fifteen hundred dollars of your own money we're gonna talk about that in a second to your business is not profitable great you've only sold a thousand dollars worth of stuff but you've spent two thousand uh so under the accrual method you've got uh negative one thousand dollars but you've got five hundred dollars in cash available because you as the owner took fifteen hundred dollars out of your personal bank account and you put it into the business yeah, I'm just wondering if like under based on the cruel versus like the cash like what if a client like pre pays or puts deposit down like how is that recorded under cruel versus like it they're ordered five thousand dollars worth of products and they send you a twenty five hundred deposit yeah that's a great question so um let's go but so under the cash method you record when payments coming to grow out. So when you get that deposit under the cash method, you record that as your income. So it was so if the deposit was twenty, five hundred and the balance is another twenty, five hundred under the cash method, you've got twenty five hundred dollars income right? Um under the accrual method you've got all five thousand dollars okay because you've sent out that bill that bill has gone out for the full you know, the invoice full five thousand um you just haven't gotten the cash back in yet if you haven't sent the bill yet if they've prepaid you that deposit um I mean in general if they're depositing if they're prepaid they're making a deposit um at least in my experience clients want to separate invoices they want the invoice just for the deposit and then the invoice for the balance I don't see too many people sending in a deposit with no invoice to match I suppose if that was the case um then under the cash method you would have your twenty five hundred in cash but under a cruel you wouldn't have anything yet because you hadn't actually build them okay and you would enter that money in later when you actually sent on the bill but in general you're going to invoice them in two pieces um you're going to voice them for the deposit and then you'll invoice them for the balance later on but it's still considered a payment even though you haven't sent them a product like even though you haven't said the product it's not a dead yet okay for sure all right let's keep going ok so we talked about contributing fifteen hundred dollars of your own money in there um but you still have no profit why why would that be well, because that's owners equity this's the other like giardini words I'm going to throw at you right now, but then I promise we basically don't have much jargon following this point, so what's orders equity owners equity is your personal stake in the business so in other words, what you could cash out with and walk away with at any given time um owners equity will affect how much cash you have in the bank, but it doesn't affect your profit. It's not an income and it's not an expense when you make an investment in your business when you take fifteen hundred out of your personal bank account, you've made an increase in owners equity um but it does not affect your balance sheet, it does not affect your profit, it doesn't affect your income and it doesn't affect your expenses. All effects is how much cash you have in the bank owners draws when you take money out, put it in your personal bank account decreases your equity um, again doesn't affect anything about the profitability income expenses of your business only what you have in the bank as cash. So this is another good example of how cash and profit or not the same thing, right? Um so there's this accounting equation this is basically what was invented in italy and like sixteenth century I think, um equity equals assets minus liabilities well, what the heck her assets and with hector liabilities why are you throwing all these words at me? I just want to learn how to add up my buttons and sequins and scissors uh equity we've just discussed assets are the things your business owns not what you own personally but what you're business owns um inventory equipment um any office supplies that you have, um and also included and there are any payments that are still due to you which, um excuse me and some businesses you will see is called accounts receivable if you've ever worked in the corporate world um, so any money that people still owe to you is technically your business is your business still owns that money even if they haven't paid you yet so that's all inside assets liabilities is the opposite it's money that you're business owes someone else. So any credit card bills that you haven't paid off yet? Uh, business loans um all that kind of stuff so equity, the amount that you could cash out with at any time is what you own minus or rather what you're business owns minus what your business owes to other people make sense um I only bring this up because this is one of those things that you need to know if you like, apply for a bank loan one of these days or if you know, you ever decided you really wanted to learn double entry bookkeeping like it's? Based on this equation, this is the accounting equation right here in general. Uh, I recommend using the accrual method just for, um, getting a better sense of how your business is doing profit wise. Um, because if you look at these examples that we brought up earlier, um, the cash in the bank does not necessarily indicate the health of your business. So the accrual method tracks how healthy your business is a little more accurately. Um, cash in some ways is easier as a method. Um but it really comes down to personal choice. You can use either one of these methods if you would like. I'm mostly going to be teaching in the direction of the accrual method today. Um, they're not vastly different as faras the actual, um, steps that you take of entering things into the ledger. Uh, but yeah, cruel will show you a little more accurately how your business is doing healthwise, but that's a really good question. Yes. It's a cruel the one accountants like better. Or is there a preference? If your deal with an accountant like will they not get angry at you? If you use a cruel methods when you turn in your books uh well I'll show you even though we're gonna cover this in the next section I'm going oh it's not on here well anyway uh this is part of the schedule c us uh irs tax form the profit and loss from your business and at the top of the form you just have to check a box which accrual method driving which accounting method did you use cash or cruel um I don't know your accountant may have different preferences one way or another uh it doesn't really matter um what's important is that you stay consistent from year to year right? That's what's really important is now which method you choose um it's just that used the same one from year to year because if you keep jumping back and forth between cash in a cruel not only is it not usually strictly legal for tax purposes because you could say like well I have no cash this year um so I'm gonna pay less in taxes but then the next year you know you've got you do it based on the accrual method and you're like oh I paid so many bill you know I have all these bills that I have to pay uh as long as you're not using it as a way to be shady uh so yeah don't switch back and forth but whichever one you choose is is up to you it's totally fine um some people really like to know in a snapshot where they're, uh, you know, business is going. And, like, how it's doing, sort of take its pulse. And I feel like the accrual method does that a little better. Um, but then some people really just, uh, like the tanja bility of knowing what they have to work with, like, knowing what the dollars and cents are that they have in their hands to work with, um, so it's, really up to you.