Here's a question from a reader that I have been meaning to answer for ages:
I have a basic budget drawn up in Excel with Budgeted and Actuals columns for my expenditures, which I am refining as the months (3 so far) go by. I use my credit card for almost everything so I know where it's all going, and I pay the balance off in full every month.Here's some info from an article I found that explains the issue a bit:
My question is, I'm not sure whether I should chalk up my Actuals in the month in which they are incurred, or in the following month, when they are paid. The one creates an accurate record for me of how much I spend in a month, while the other gives a picture of my current cash flow.
Which is the usual way of tracking this? Thanks in advance for your thoughts.
Cash vs. Accrual Accounting
There are two basic accounting methods available to most small businesses: cash or accrual.
Cash method. If you use the cash method of accounting, you record income only when you receive cash from your customers. You record an expense only when you write the check to the vendor. Most individuals use the cash method for their personal finances because it's simpler and less time-consuming. However, this method can distort your income and expenses, especially if you extend credit to your customers, if you buy on credit from your suppliers, or you keep an inventory of the products you sell.
Accrual method. With the accrual method, you record income when the sale occurs, whether it be the delivery of a product or the rendering of a service on your part, regardless of when you get paid. You record an expense when you receive goods or services, even though you may not pay for them until later. The accrual method gives you a more accurate picture of your financial situation than the cash method. This is because you record income on the books when it is truly earned, and you record expenses when they are incurred. Income earned in one period is accurately matched against the expenses that correspond to that period, so you get a better picture of your net profits for each period.
Pros and cons. The cash method is easier to maintain because you don't record income until you receive the cash, and you don't record an expense until the cash is paid. With the accrual method, you will typically record more transactions. For example, if you make a sale on account (or, on credit), you would record the transaction at the time of the sale, with an entry to the receivables account. Then, when the customer pays their bill, you will record the receipt on account as another transaction. With the cash method, the only transaction that is recorded is when the customer pays the bill. If you are using computer software to do your accounting, this is probably not a big concern, since the computer program automates much of the extra effort required by the accrual method.
This article targets a business user, but you can see what the issues are for personal finance as well. Do you want to have to enter everything twice, and maintain payables and receivables accounts? Sounds like a nuisance to me. But if your cash is tight enough that you want to monitor cash flow very carefully, maybe the accrual method is the way to go. I would recommend using the cash method, and recording your expenses as they occur, and just stay aware of what the running balance is on a credit card so you'll know how much cash you'll actually be paying out when the bill comes due the following month.
Anyone else have any thoughts on this? I never took Accounting 101 so there may be some points I'm missing...