This article is an excerpt from the CharityVillage x Enkel Backoffice Solutions webinar, Financial Statement Boot Camp: How to read, understand, and use financial statements to better run your nonprofit. View the full video recording here, or scroll to the end of the article to watch the video.

Let’s look at cash-based versus accrual accounting. The main difference between these two is the timing of when you’re recording your revenue or expenses.

We’re just going to start with an example. You’ve received an invoice for consulting fees and the consultant provided these services back in August. But you’ve just received the invoice now, in October. You want to record it and you want to pay it now.

So, cash-based accounting records the expense and the payment in October, even though the fees were actually incurred in August. So, let’s say your consultant was consulting for an event or program that was running in August. Cash-based accounting is going to record that in October. So not in the month that the actual program or event took place or when these expenses were incurred.

Accrual accounting, however, records the expense for the bill for consulting back in August when it was incurred. And then the payment is going to be recorded in the month that you actually made the payment, which is October. 

So why would we want to choose one over the other?

Well, cash-based accounting is more simple, it’s less complex. It’s used by a lot of small businesses and self-employed individuals. 

So, people that just have a little business, they’ll run cash accounting. Statement of operations align with your cash flows in and out, meaning your revenues and expenses will always match your bank statement. 

Accrual accounting, however, follows Generally Accepted Accounting Principles. It’s required for some organizations. It provides a more accurate view of your organization’s financial performance. And it is required for audits or review engagements. And it may be requested by stakeholders, like a funder. It is a more accurate picture of your organization’s financial position, and sustainability.

So, we’re going to take a look at an example here.

The top example is cash basis. So, the revenue that is coming in is based on money that was deposited that month into the bank. The expenses are expenses that were paid that month, it’s cash basis.

You can see what ends up happening is in October it looks like we’ve taken a big loss because we’ve maybe paid a lot of bills that month, but we didn’t get a lot of big deposits. And then in November, it kind of evened out and then in December it looks like we suddenly had a surplus.

With accrual-based accounting, you can see things look a lot more even. A lot more in-line. We’re recognizing revenue when it’s actually incurred, and expenses as well. So, it provides you a better picture and a more accurate picture of the funds that are coming in and out of your organization. 

In a nutshell, while the cash basis of accounting is a simpler method, the accrual basis of accounting presents a more accurate picture of your organization’s financial position and operating results because transactions are captured in real-time in the period that they occurred.  

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