The main difference between cash basis and accrual accounting is the specific timing of when revenue and expenses are recognized on your business’ P&L. The cash basis method immediately recognizes revenue and expenses, while the accrual method records when the revenue and expenses occur, even if the cash hasn’t actually exchanged hands.
Cash Basis Method:
Revenue is recorded on your company’s P&L when cash is received. Similarly, expenses are recorded when cash is paid out. Cash basis accounting is easier and is normally used by small businesses and for personal finance accounting.
For example, if a customer buys an annual license of your software product in November for $12,000, you will record $12,000 in revenue in November on your P&L.
The accrual method records revenue when your company’s product is required to be delivered to your customer or when expenses are expected to be paid out. The accrual method of accounting is far preferable for SaaS businesses. When using the accrual method, you spread expected revenue across the months your product will be delivered.
So, for example, if a customer signs an annual contract for $12,000 in November, and they will have your software product’s license from January-December of the next year, you will record $1,000 in revenue for each month from January through December. Similarly, your cost of goods sold will be split evenly through the months of January and December.
What’s right for my software company?
The accrual method is preferable for SaaS companies specifically, since it smooths out revenue and expenses, allowing for simpler tracking and observing trends. Additionally, for SaaS companies, the accrual method will track along with MRR, providing easy metrics when speaking with stakeholders, investors, and others.