Cash accounting

to see the difference between cash accounting and accrual accounting I'm going to go through this little example and first I'm going to account for things using a cash basis of accounting and then we'll do it with an accrual basis and just so you have some context the cash basis is anytime you get cash from a customer you would count that as revenue and any time you have to spend cash you count that as an expense and you'll see that that's what most small businesses do while most slightly more sophisticated businesses would use accrual-based accounting because that matches up kind of the your your actual expenses and your revenue a little bit better in each period so let's just go through this example using the cash basis first and we're going to assume that we start off with no money so in month one you cater an event where the cost to you was $100 the customer pays you $200 for your services and maybe they pay your $200 ahead of time so that you have the cash to go buy the food and the paper cups and paper plates or whatever so you get $200 in revenue this is a cash basis of accounting and you had to spend a hundred dollars of that on supplies and maybe you have to hire some help and you have to pay yourself a salary so if you got $200 and you used 100 of that your profit here I'll do profit in green as well your profit is going to be that's not green your profit is going to be $100 and if you started with no cash your cash at the end of period this is going to be the cash at the end of month one you will now have 100 dollars of cash now let's go to month two you cater an event where the cost to you was $200 the cost was $200 you and the customer agree that they can pay you $400 the next month so in this month we have to use $200 maybe our bank lets its overdraft so let's say we should write this is an expense so I don't have to write negative we're assuming this is going out I'll write it in red so we are going to use $200 but we don't get any revenue because we're doing the cash basis accounting the customer is not paying us in that month they're paying us $400 the next month so we get no revenue in that period so it looks like we got no we had $200 of expenses our profit here is going to be negative negative $200 and when we look at how much cash we had $100 of cash entering into month 2 we're using $200 of that and so now we've kind of overdrawn our bank balance maybe we owe our bank now $100 let's go to month to month 2 you get $400 from the customer in the previous month you also get $200 in advance from a customer that you have to cater for next month so we've done no catering this month but we've gotten a lot of money we got 400 dollars from the previous month's customer and $200 for customer that you're going to cater for next month so we got $600 on the cash basis in in revenue and we had no expenses in that month so we have 600 dollars in profit and our cash balance increases by $600 so at the end of this month we now have $500 now month for you cater the last customers event it costs you $100 so once again you just have to spend I want to do that in magenta you just have to spend the hundred dollars in month for to cater the actual event but you got no revenue in that month so it looks like you took a loss negative $100 and then your cash balance will go down to your cash balance will go down to $400 so this is a cash basis this is how a lot of businesses run it but as you can see there's a problem here it looks like our profit is jumping all over the place sometimes we're profitable sometimes we're not sometimes we're profitable sometimes we're not even though our business is a little bit steadier then that would a seem to imply