Cash-basis accounting records financial events based on cash flows. For example, when you pay your rent your landlord would record an income event when you make the payment. The landlord records an expense event when he pays the rental agent their fee for your apartment. It is the accounting method used by most individuals, and by some businesses that have limited payables or receivables or whose income and expense cash flows are closely associated with each other in time.
Accrual-basis accounting records financial events based on events that change your net worth (the amount owed to you less the amount you owe others). Standard practice is to record expenses with the incomes they are associated with. For example, your landlord would record an income event on the day your rent comes due (you owe it to him). He records an expense event when the fee owed to the rental agent comes due for your apartment that month (he owes it to the agent). The details of the actual cash flows and their timing are tracked by bookkeeping.
Companies that have extended or used credit more expansively will use (and in the United States may be required by the Internal Revenue Service to use) the accrual-basis method of accounting.
Using cash-basis accounting, income and expenses are credited and debited only when cash is received or paid out. But using accrual-basis accounting, receivables are debited and payables are credited (and, for tax purposes, a profit or loss is thereby determined), even though as yet, no cash has been received or paid out.
On one hand, a small business such as a fruit stand, which buys its inventory daily for cash at a wholesale market, sells the inventory for cash, and throws away what didn't sell, can get an accurate picture of its profits or losses using cash-basis accounting. On the other hand, a remodeling business that gives customers 90 days to pay and that procures materials on account at the lumber yard, must use the accrual method to gain an accurate picture of its financial condition.
