Why you Need to know Cash vs. Accrual Accounting

Welcome back to my channel. My name is Mundo. In today's video, we are going to kick off a full accounting series when we're going to take you from zero to hero in terms of everything you need to know from an accounting perspective. Booking invoices, booking expenses, understanding the profit and loss statement, understanding the balance sheet and how everything fits together. We're going to talk about cash, and we're going to talk about accrual accounting, all of that stuff. So by time we're done with this series, you're going to know exactly what to do with your financial statements so you can do your own bookkeeping. And let's say maybe you don't even want to do bookkeeping. Well, at least you're going to have the foundational knowledge to understand what's going on in your business and understand how to read financial statements. You know, that's going to allow you to have better communications with your cpa. When you can look at your financial statements and, and understand what's going on, you can then have a more productful conversation with your accountant and work together as one cohesive team to explore additional opportunities like tax savings and all that other good stuff and value that your CPA brings. All right, so let's go ahead and dive right in. So before we jump into QuickBooks online and journal entries and all that good stuff, we really need to lay down some foundational understanding of accounting because that is critical. If we just jump right in to start reviewing journal entries and things we're doing on the P L versus the balance sheet, you're going to be completely confused. And I hate watching videos where you have a problem you're trying to solve, and they show you steps one through four, and then they jump right to steps eight, nine, and ten. And then you're sitting there wondering, okay, well, what happened in between there? Right? I'm definitely not going to do that. We're going to get into the weeds. But before we get into the weeds of accounting and showing you step by step, we need to lay down the foundational knowledge. All right, so what's the difference between cash and accrual accounting? So if we break this down into a very simple explanation, let's look at it this way. So let's say you know you're Gonna bring in $5,000 of revenue in one month, right? But you don't know exactly when that $5,000 of revenue is gonna come in. Let's say that you rendered services and completed the work for this $5,000, but your customer is going to pay you over time. Right. You don't know whether they're going to pay you tomorrow or two weeks from now. In cash accounting, we are going to record that $5,000 of income whenever it's received. So if we're in the month of March and your customer pays you $2,000 of the five, we're only going to record $2,000 under the cash accounting method. Let's say you get the other $3,000 in the month of April. Well, that's when you're going to record that $3,000. You're only going to record income and also corresponding expenses in the month in which it actually hits your bank account and clears and post to your bank balance. It really is a representation of your checking account. Right. So everything coming in and everything. That is what is going to be recorded under cash accounting. So if you are trying to plan for your business and do some forecasting and try to understand profitability, cash accounting is not really great to follow along. So if you're really trying to plan and forecast the profitability of your business, you probably want to understand where all your income is coming from and where all your expenses are coming from in the same period. Right. If you're rendering $5,000 worth of services, you want to know how much of that $5,000 worth of income that's going to be coming in? How much did that cost you? Right. Did it cost you 2,000? Did it cost you 3,000? Like, how are you going to figure out your gross profit if you can't line up your income and line up your expenses? So that's the difference in accrual accounting. Let's say in that example, you, you receive $2,000 in March, $3,000 in April. Cash accounting, we flip that over to accrual accounting. We are going to now look at it from a different lens. We're going to take that $5,000, and although it hit our bank account in different months, we're going to look at it from the perspective of all of that money was earned and therefore recorded on our financial statements and in the same month. Right. So we're going to take that $5,000. We're going to record that in one month, and then we're also going to take the associated expenses. So let's say it's $3,000. We're going to make sure that's recorded in the same month. What we're trying to do in accrual accounting is line up all of our expenses for the month and all of our income for the month. So that way we can look at our financial statements and profitability. In an apples to apples example, we're not seeing a slug of expenses, you know, related to a big project we did three months ago in one month. And let's say the timing of when we received income was delayed. So now, you know, it just gets too messy and we can't even really understand how profitable we are. That's why we want to line up all of our income and all of our expenses from an accounting perspective on our books to know what our true profitability is. And that's really the main difference between cash accounting and accrual accounting. So I hope that's a very simple explanation to help you understand the difference between cash and accrual accounting. Understanding that concept is going to be critical for our next videos where we're going to dive into getting your QuickBooks account set up, getting your bank accounts linked, going through your chart of accounts, that's going to be critical. So we're going to go through and we're going to map our chart of accounts and set up our profit and loss and balance sheet statements in a structured way so that way we can make meaningful inferences from our profitability monthly. Right. So we want to set up our accounting statements in a way that is easy to read, you know, from a monthly perspective. We don't want to have this complicated web of expenses scattered all over the place. We want to be able to group things into buckets so that way we can clearly look at our profit and loss statement and be able to understand, okay, where are key expense drivers? That's all the stuff that we're going to get into in this video series. So go ahead and like and subscribe below. I promise. Promise you, you're going to want to stay tuned for this full accounting series that we're going to put on for you. At the end of it, you're going to know exactly how to record income and expenses, and you're probably going to be better than your average bookkeeper by time we're done. See you next time.