There are two main kinds of accounting methods: accrual accounting and cash accounting. Depending on who is speaking, accounting “methods” may also extend to the GAAP vs pro-forma distinction.

For the most part, accounting methods can be defined based on the year in which the revenues and expenses are put on the books. In cash accounting, only the revenues and expenses which are collected and paid in the current year or period are documented.

This works well for most sole proprietors and individuals, because there is only so much to keep up with, basically, and this is an easy way of documenting a real cash flow. Small businesses with sales under $5 million a year have complete freedom to choose either method of accounting.

For larger businesses, GAAP usually stipulates that the accrual method is used. Accrual accounting documents revenue and expenses the moment they enter the picture, not necessarily when they are paid out or received.

This is a good way to make sure that there is enough money left to pay all the bills when there are a lot of moving parts. One must be sure to move expected revenues to the Receivables, of course, to avoid misjudging how much cash is on hand.