Accrual accounting vs cash accounting: why profit isn't cash
What the accrual basis means, how it differs from cash accounting, the four kinds of accrual and deferral, and a worked month showing exactly why profit and cash flow differ.
Foundations · Updated 21 October 2026
There are two ways to decide when income and costs belong to a period. Cash accounting records them when money is received or paid. Accrual accounting records them when they are earned or incurred, whatever the timing of the cash. Financial statements prepared under IFRS or US GAAP use the accrual basis (the cash flow statement is the exception — it reports cash, by design).
The difference matters because the two answers to "how did we do this month?" can be very far apart, and only one of them tells you whether the business is actually profitable.
The accrual principle in one paragraph
Under accrual accounting, revenue is recognised when the business has done what it promised — delivered the goods or performed the service — and expenses are recognised when the resources are used up in earning that revenue. Cash can arrive before, at the same time, or after. The effects of a transaction are recorded in the period they relate to, and any cash that hasn't caught up yet sits on the statement of financial position as a receivable, a payable, a prepayment or a deferred (unearned) revenue balance.
Cash basis versus accrual basis
| Cash basis | Accrual basis | |
|---|---|---|
| Revenue recorded | When the customer pays | When the work is done or goods delivered |
| Expense recorded | When the bill is paid | When the cost is incurred |
| Receivables and payables | Not recorded | Recorded |
| Long-lived assets | Often expensed when paid | Capitalised and depreciated |
| Measures | Cash movements | Performance for the period |
| Used for | Very small businesses, some tax regimes, personal budgets | IFRS and US GAAP financial statements; most businesses |
Cash accounting is simpler and shows the bank position. Its weakness is that it can be moved by timing alone: chase every customer on the last day of the month and delay paying suppliers, and a poor month looks excellent.
Accruals and deferrals: the four cases
Every timing difference between cash and recognition falls into one of four boxes.
| Revenue | Expense | |
|---|---|---|
| Earned or incurred first, cash later (accrual) | Accrued revenue / receivable — work done, not yet invoiced or paid | Accrued expense — cost incurred, not yet paid (wages, utilities, interest) |
| Cash first, earned or incurred later (deferral) | Unearned (deferred) revenue — a liability until the work is done | Prepaid expense — an asset until the benefit is used up |
At each period end, adjusting entries move amounts across these boxes so that the statements show what the period actually earned and used. The guide to adjusting journal entries covers the entries; here we focus on the effect.
A worked month: Merrow Tutoring
Merrow Tutoring runs exam-preparation courses. Here is everything that happened in March.
- Invoiced schools 18,000 for March tuition; 11,000 was paid in March and the rest is due in April.
- Collected 4,000 from invoices issued in February.
- Received 6,000 in advance for a course running April to June.
- Paid 2,400 on 1 March for a twelve-month software licence.
- Tutors' March salaries were 7,500: 6,000 paid on 31 March and 1,500 paid on 2 April.
- Paid February's electricity bill of 300 (recorded as a payable in February).
- March's electricity of 350 is billed in April.
- Bought a laptop for 1,800 cash on 1 March, to be used for 36 months with no residual value.
The cash view
Receipts: 11,000 + 4,000 + 6,000 = 21,000. Payments: 2,400 + 6,000 + 300 + 1,800 = 10,500. Net cash inflow for March: 10,500.
The accrual view
| Item | March amount | Why |
|---|---|---|
| Tuition revenue | 18,000 | All March work is earned, paid or not |
| Salaries | (7,500) | All March salaries, including 1,500 paid in April |
| Software licence | (200) | One month of twelve: 2,400 ÷ 12 |
| Electricity | (350) | March usage, billed in April |
| Depreciation of laptop | (50) | 1,800 ÷ 36 months |
| Profit for March | 9,900 |
The February collection (4,000) and February electricity (300) belong to February, so they are not in March profit. The 6,000 advance is not revenue yet: it is a liability until the courses are taught.
Why they differ
| Amount | |
|---|---|
| Profit for March | 9,900 |
| Add: depreciation (an expense with no cash payment) | 50 |
| Less: receivables up, net (7,000 new unpaid March invoices − 4,000 February invoices collected) | (3,000) |
| Add: unearned revenue received in advance | 6,000 |
| Less: prepaid software (2,400 paid − 200 expensed) | (2,200) |
| Add: salaries payable at 31 March | 1,500 |
| Add: electricity payable up, net (350 accrued − 300 February bill paid) | 50 |
| Less: laptop bought for cash (an investment, not an expense) | (1,800) |
| Net cash inflow | 10,500 |
This reconciliation is the indirect-method cash flow statement in miniature, and it is how analysts explain why a profitable company can be short of cash — or why a cash-rich month can hide weak trading. The cash flow statement guide builds it out fully.
Which number is "right"? Both, for different questions. The bank wants 10,500; the owner deciding whether the tuition business is worth running wants 9,900 — and should know that 6,000 of March's cash is an obligation to teach courses next quarter.
Where the judgement comes in
Accrual accounting needs estimates and cut-off decisions that cash accounting avoids:
- When is revenue earned? For a course delivered over three months, revenue is recognised as it is taught. For goods, it is usually when control passes to the customer. IFRS 15 and its US GAAP equivalent (ASC 606) set out a five-step model for this; the five-step revenue model lesson works through it.
- Has the cost been incurred? Staff time worked, electricity used and interest accrued are expenses of the period even when no bill has arrived.
- How long will an asset last? Depreciation spreads the laptop's cost over its useful life, which is an estimate. See the depreciation guide.
- Cut-off. Goods shipped on 31 March or 1 April? Work completed before or after the year-end? The cut-off lesson tests exactly these decisions.
Common mistakes
- Recognising advance payments as revenue. Cash received for work not yet done is a liability.
- Recognising last period's revenue when its cash arrives. Collecting a February invoice in March is not March revenue.
- Forgetting accrued expenses. If staff, utilities or lenders have provided value this period and the bill hasn't arrived, the expense still belongs here.
- Expensing assets that last for years. The laptop is capitalised and depreciated, not charged in full in the month it was bought.
- Double-counting. If an accrual was recorded last month, the payment this month clears the liability — it isn't a new expense. Reversing entries help avoid this; see the reversing entries lesson.
Frequently asked questions
Is accrual accounting required?
General-purpose financial statements under IFRS and US GAAP are prepared on the accrual basis. Some small businesses may use cash accounting for tax or internal purposes where local rules allow it; check the rules where you work.
Why can a profitable business run out of cash?
Because profit counts revenue that hasn't been collected and ignores cash spent on assets, inventory and loan repayments. Fast-growing businesses are especially exposed: receivables and inventory grow ahead of collections. The profit versus cash lesson has graded examples.
Is a prepayment an expense?
Not when paid. A prepayment is an asset that becomes an expense as the benefit is consumed — here, 200 a month for twelve months.
Practise it
Start with the free accrual versus cash lesson, then the graded adjusting-entry lessons on accruals and deferrals. The statement linking lab lets you change a treatment and watch profit, assets and cash move. For realistic month-end practice, the Retail Month-End case and the Month-end accountant pathway put accruals and deferrals into a full close.