Accrual vs cash
Read firstThe three statements. Valuation without accounting is memorization.
A small print shop opens in January. Over three months it does obviously good business, and at the end of March its bank account is nearly empty. Nothing has gone wrong and no one has stolen anything. It is worth walking through slowly, with the numbers in front of you.
Three months, two sets of books
The three months, in order.
- January. Buys $30,000 of paper and ink, pays cash. Prints a $20,000 job for a corporate client, invoices on 45-day terms. Pays $4,000 of rent and wages.
- February. Prints another $25,000 job, also on 45-day terms. Uses $18,000 of the paper bought in January. Pays $4,000 of rent and wages. Collects nothing.
- March. Collects the $20,000 January invoice. Prints a $15,000 job, cash on delivery. Uses $12,000 of paper. Pays $4,000 of rent and wages.
| Jan | Feb | Mar | |
|---|---|---|---|
| Accrual: revenue | 20,000 | 45,000 | 60,000 |
| Accrual: cost of goods sold | negative 12,000 | negative 30,000 | negative 42,000 |
| Accrual: rent and wages | negative 4,000 | negative 8,000 | negative 12,000 |
| Accrual: profit | 4,000 | 7,000 | 6,000 |
| Cash: collected | 0 | 0 | 35,000 |
| Cash: paid out | negative 34,000 | negative 38,000 | negative 42,000 |
| Cash: net | negative 34,000 | negative 38,000 | negative 7,000 |
By the end of March the accrual books say the shop made $6,000. The bank says it is down $7,000. Both are correct. The accrual books are answering "is this a good business?" and the cash record is answering "can it pay April's rent?"
The $13,000 gap is entirely explained by two things: $25,000 of the shop has earned but not collected, less $12,000 of paper it paid for and has not used. Both are , and working capital is where growing businesses go to die.
The rules, briefly, because the mechanism is the lesson
under ASC 606 turns on control. Revenue lands when the customer gets control of what they bought, which can be a moment (a printed job handed over) or a period (a year of software access). Everything else in the standard is machinery for deciding which of those applies.
The matching principle does the other half: costs are recognized in the period the related revenue is. That is why the $30,000 of paper does not all hit January. Only the $12,000 actually used shows up as , and the rest waits on the as .
Money collected before the work is done runs the other way. That is : cash in hand, a liability on the books, and revenue recognized as the obligation is delivered.
From the money track
Unit economics, on the same idea
The entrepreneurship guide works the cash flow trap from the founder's side, without the accounting vocabulary.
Test yourself
01A company signs a $1.2M three-year contract and collects the whole amount up front. What does year one look like?
Revenue of $400,000, cash of $1,200,000, and a deferred revenue liability of $800,000. Cash flow looks spectacular and the income statement looks ordinary. The follow-up is what happens in year three: revenue of $400,000, cash of zero, and the liability unwinding. A subscription business growing fast looks like a cash machine, and a subscription business that stops growing looks very different very quickly.
02Which basis would you use to run a lemonade stand, and which to run a manufacturer?
Cash for the stand, accrual for the manufacturer. The stand has no inventory to speak of, no receivables, and no equipment. The manufacturer has all three, and cash accounting would show a catastrophic loss in the month it bought a machine and an implausible profit for the ten years afterwards. The complexity of accrual accounting exists in proportion to the complexity of the business.
03Why does the tax code let small businesses use cash accounting?
Because the compliance cost of accrual accounting is real and the timing differences wash out over the life of the business. Under current US rules a business with average gross receipts under roughly $30M can use the cash method. It is a simplification, and it also creates the year-end habit of prepaying expenses in December to move a deduction, which accrual accounting quietly removes.
A tutor that knows this lesson. It asks before it explains, and it will not tell you what to do with your own money.
Every figure in this lesson that names a company comes from Target Corporation's Form 10-K for Fiscal 2025, the year ended 2026-01-31, filed 2026-03-11. Educational material, not investment advice.