Cash vs. Accrual Accounting: Does it Really Matter?

Proper accounting practices lie at the core of operations for any organization. Yet for many non-profits, accounting is relegated to the bottom of the priority list. A lack of awareness about accounting fundamentals also hampers the effectiveness of non-profit boards, who may struggle to provide adequate oversight of organizational finances.   

In my experience, one of the biggest points of confusion for non-profit executives and board members stems from the accounting method employed by their organization. 

Most people are familiar with the simplest method of accounting, called cash accounting. With cash accounting, revenue and expenses are recognized as soon as they occur (i.e., as soon as they are debited or credited from a bank account). The cash method is straightforward - no need to track revenue that has not been collected or payments that are coming down the pipe.

The simplicity of cash accounting is what makes the method so attractive. Most people manage their personal checking account with cash accounting. They always know where they stand in terms of cash available to spend. Smaller organizations without many transactions can also benefit from the cash method. 

But what happens when an organization’s transactions grow more complex? Or when executives and board members request more detailed insight into the financial health of an organization? Enter the second method of accounting, known as accrual accounting. 

Under the accrual accounting method, transactions are recorded when a good or service is provided rather than when payment is made or received. For example, if a member of a trade association signs up for an annual membership in January, the revenue is booked in January, even if the member does not actually pay the invoice until June. The revenue is even booked if the member ever pays at all!

At first glance the accrual accounting method may seem unnecessarily complex. There is no doubt that tracking transactions under the accrual method requires more careful review and consideration of additional variables. However, for an organization, accrual accounting also provides several benefits. Chief among them are the enhanced ability to understand expected cash flows and accurately assess the financial realities of the organization. 

Of course it matters when cash is actually received or paid out. But a properly managed non-profit organization is typically able to withstand short-term fluctuations in their cash flow. There are more meaningful variables to consider when examining how an organization is performing and planning for the future. These include understanding when services are provided, when most memberships are sold, and when debt payments are coming due.

For-profit businesses intuitively understand the importance of using their accounting method to glean insights on how money is flowing through their organization. That is why the wide majority of them rely on the accrual accounting method. Cash accounting is far easier to implement, but the insight it provides is far more limited. 

If you are not familiar with accrual accounting, it can be challenging to understand how the method aligns with the immediate cash flow demands of your organization. Luckily, Eden Advisors can help you uncover the benefits of more advanced accounting processes and advise on the best way to present accounting reports to your Board of Directors.