The same month can be your best or your worst depending on which basis you use. What each one shows, and why you need to be able to read both.
12 min read · Level 2
Neither basis is the truth. Cash tells you whether you can pay people; accrual tells you whether the business works. A founder who only reads cash panics at a slow-paying customer and celebrates an annual prepayment they have not earned. A founder who only reads accrual is profitable right up until the wages bounce. Financial maturity is not picking the sophisticated one — it is holding both in your head and knowing which question each one answers.
Cash basis records revenue when money arrives and costs when money leaves.
Accrual basis records revenue when it is earned and costs when they are incurred, whenever the money moves.
Most small companies keep books on accrual and watch cash separately.
Because the gap between them is where companies die. An accrual P&L can show a profitable quarter while the bank account drains, and a cash view can show a wonderful month that was really twelve months of service paid upfront.
And because everyone you report to assumes accrual. An investor asking for your P&L is asking for the accrual one; handing over a cash view without saying so makes your numbers look erratic and you look unaware.
March. You deliver £30,000 of work, invoice on 60-day terms, and receive £12,000 of annual prepayments from two other customers. You spend £20,000 on salaries and hosting.
Cash basis: revenue £12,000, costs £20,000 → £8,000 loss. Looks like a bad month.
Accrual basis: revenue £31,000 (£30,000 earned plus £1,000 of the prepayments), costs £20,000 → £11,000 profit. Looks like a great month.
Both are correct. They answer different questions.
The actually useful view is both together: you earned £31,000, you collected £12,000, £30,000 is sitting in receivables due in May, and £11,000 of what you collected is deferred revenue you still owe as service. Your bank balance fell £8,000 in a profitable month, and unless you know why, you will make a bad decision in April.
First-time founders report whichever basis makes the month look better, often without realising they have switched. It shows up immediately as revenue that jumps around for no reason anyone can explain, and it costs credibility in diligence.
The second mistake: treating annual prepayments as revenue on arrival. That £12,000 is mostly the customer's money until you have done the work. Companies that spend it and then face a refund wave discover the distinction the hard way.
The third: choosing accrual and then never looking at cash. Accrual is the honest performance view and it will not tell you that payroll clears next Tuesday.
It is what investors, lenders and acquirers expect, and it is what makes month-to-month comparison meaningful.
An annual contract is one twelfth per month, not a spike. The rest sits as deferred revenue.
Opening balance, in, out, closing balance. Weekly. This is the one that tells you whether you can make payroll.
Profit minus change in cash, every month. The difference is always explainable — receivables, prepayments, a big annual bill — and if you cannot explain it, something is recorded wrong.
One sentence in any report. It costs nothing and it prevents the most common misunderstanding in startup finance.
Decide once, early, and stay consistent. Revisit only if your model changes fundamentally — for instance moving from one-off projects to subscriptions.
If you take payment by card at the point of sale and have no invoicing, the two bases nearly coincide and the distinction is mostly academic. It becomes critical the day you send your first invoice.
When subscription companies file to go public, deferred revenue is one of the most scrutinised lines in the document. It is money already collected for service not yet delivered — simultaneously a sign of commercial strength (customers paid upfront) and a liability (you owe them the year). Public filings from subscription businesses routinely carry deferred revenue balances comparable to a large share of annual revenue.
Large deferred revenue is a good problem and still a liability. Track it as its own line from your first annual contract, not from your fiftieth.
The common pattern: a small company offers two months free for annual upfront payment, sells a dozen of them, sees the largest bank balance in its history, and hires against it. Six months later the cash is spent and the revenue for the remaining half-year has already been collected — so incoming cash collapses while the service obligation continues.
Annual prepay is excellent financing and terrible income. Model the cash-flat months before you run the promotion, not after.
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