When you run a small business in Canada, keeping track of your income and expenses is very important. There are two main ways to do this: cash basis accounting and accrual accounting.

Think of these methods as two different ways to keep track of what you earn and spend. We'll look at both methods in simple terms so you can decide which one is best for your business.

What is cash basis accounting?

Think of the cash basis method of accounting like a piggy bank or bank account. You only count the money when it actually goes into or comes out of your account. It's easy because you track the cash you have right now.

Say you sell a handmade bracelet in May but don't get paid until June. With cash basis accounting, you count this sale in June, when you receive the money — not at the time of the sale.

What is accrual accounting?

Accrual accounting is sort of like writing down promises. You write down money you expect to get and money you plan to pay, even if the cash hasn’t traded hands yet. It’s like keeping track of what's going to happen in the future to make sure you don’t forget.

Imagine you mow someone's lawn in March but they don’t pay you until April. With accrual accounting, you count this as income in March, when you did the work — even though the cash comes in April.

The same goes for paying bills. If you buy gas for your lawn-mower on credit in March, but you don't pay the bill until April, you count the expense as happening in March when you got the fuel — even though you didn't pay for it until April.

Accrual vs. cash accounting

Accrual and cash accounting are like two different languages for speaking about your business's money. Imagine you're running a lemonade stand. If you use cash accounting, you only think about the money when it actually enters or leaves your cash-box, like when you buy lemons or when a customer buys a drink.

Cash accounting is all about the cash you have right now.

Accrual accounting, on the other hand, is like tracking what's happened before you receive or pay the money. Even if a customer says they'll pay you next week for a lemonade they take today, you count that as money made today. Similarly, if you promise to pay for lemons next week, you count it as money spent today.

So, while cash accounting gives you a snapshot of what's in your cash-box right now, accrual accounting gives you a broader picture, including what's promised for the future.

Which method is better?

In Canada, the choice between cash and accrual accounting isn't just a matter of preference. It also depends on regulatory guidelines and the nature of your business. Cash accounting is straightforward and well-suited for smaller businesses or certain industries where immediate cash transactions are the norm, such as independent contractors, small retailers, or service-based businesses like hair salons.

However, it's important to note that Canadian tax law only permits certain types of businesses to use cash accounting for tax purposes. This method is particularly advantageous for its simplicity and direct reflection of cash flow, making it ideal for businesses with simple transactions.

On the other hand, accrual accounting is necessary for larger businesses or those in industries where transactions occur over longer periods, like construction companies or businesses with inventory. This method provides a more accurate financial picture over time, which is crucial for businesses that need to manage more complex financial activities and comply with Canadian accounting standards for revenue recognition and financial reporting.

Choosing between cash basis and accrual accounting might seem tricky, but it's just about understanding how you want to look at your money. QuickBooks makes it easy to handle both ways, so you can focus on making your business awesome. Check out QuickBooks to make managing your money simple and fun.

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