Cash vs. accrual accounting
By SuperdayReps · Michigan Ross Undergrad | Wharton MBA · ex-Citi | ex-Greenhill · Former Head Mentor at a Leading IB Prep Service
9 min read · updated October 14, 2026
A consultant finishes a $10,000 project on December 20th. The client pays on January 15th. Which year did the consultant make that money?
There are two honest answers, and the gap between them is the foundation of everything on the three statements. If you go by the bank account, it is next year. If you go by the work, it is this year. Accountants call the first approach cash accounting and the second accrual accounting, and every public company you will ever value uses the second one.
Two ways to keep score
Cash accounting is how most people run their personal finances. Money comes in, you record income. Money goes out, you record an expense. It is simple and it never lies about the bank balance. Plenty of small businesses keep their books this way.
Accrual accounting records economic events when they happen, not when they are paid for. Revenue is recorded when it is earned. Expenses are recorded when they are incurred. The cash can arrive before, after, or at the same time, and the income statement does not care.
Run the consultant through both:
| Cash basis | Accrual basis | |
|---|---|---|
| December revenue | $0 | $10,000 |
| January revenue | $10,000 | $0 |
| December balance sheet | nothing | Accounts receivable $10,000 |
Under accrual, the December entry is revenue up $10,000 and accounts receivable up $10,000. In January, when the check clears, cash goes up $10,000 and receivables go down $10,000. No new revenue, because the earning already happened.
Why bother? Because cash accounting can be gamed by timing and it distorts the picture of a period. A company could look wildly profitable in a quarter just by collecting a pile of old invoices, or look terrible because it prepaid a year of rent. Accrual accounting asks a better question: what did the business actually do this quarter? That is the question an investor is paying to answer, which is why US GAAP and IFRS both require it.
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Frequently asked
- What is the difference between cash and accrual accounting?
- Cash accounting records revenue when the money arrives and expenses when the money leaves. Accrual accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash moves. Public companies must use accrual accounting, because it shows what the business actually did in the period rather than when its bank account happened to change.
- What is the matching principle?
- The matching principle says an expense belongs in the same period as the revenue it helped produce. Inventory is expensed as cost of goods sold when the product is sold, not when it is bought, and a machine is depreciated over the years it is used, not expensed the day it is paid for. Matching is what makes a period's profit meaningful.
- When is revenue recognized?
- When the company has done what it promised the customer, meaning control of the good or service has passed to them. For a retail sale that is the moment of sale. For a subscription it is spread evenly over the service period. For a long construction or engineering contract it is usually recognized over time as the work gets done, often measured by the share of total expected cost incurred so far.
- Why are net income and cash flow different?
- Three reasons. Working capital: revenue booked but not yet collected, inventory bought but not yet sold, bills received but not yet paid. Non-cash charges such as depreciation and stock-based compensation, which reduce profit with no cash out the door. And capital spending, which is cash out today but reaches the income statement only gradually through depreciation. The cash flow statement exists to reconcile the two.
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