Cash vs. Accrual Accounting and What Contractors Need to Know
If you’re a contractor looking at your Profit & Loss statement and wondering, “Are we actually making money?”, the answer can depend on whether you’re looking at your books on a cash or accrual basis.
Understanding the difference is especially important for contractors because construction businesses often invoice customers, receive payments weeks or months later, purchase materials before getting paid, and manage projects that span multiple accounting periods.
The way your books are reported can change what you see on your Profit & Loss statement.
What Is Cash-Basis Accounting?
Cash-basis accounting records revenue when you receive the money and expenses when you pay them.
For example, imagine you complete a $30,000 project in June, but your customer doesn’t pay the invoice until July.
Under cash-basis accounting, that $30,000 would generally appear as revenue in July.
Cash accounting can be easier to understand because it follows the movement of money through your bank account. However, it doesn’t always provide the clearest picture of how profitable the work was during the month it was performed.
What Is Accrual-Basis Accounting?
Accrual accounting records revenue when it is earned and expenses when they are incurred, regardless of when cash actually changes hands.
Using the same example, if you earned $30,000 from a project in June but didn’t receive payment until July, accrual accounting would generally recognize the revenue in June.
The same principle applies to expenses.
If you receive a $10,000 materials bill in June but don’t pay it until July, accrual accounting would generally recognize that expense in June.
This creates a better connection between the revenue earned and the expenses associated with earning that revenue.
Why Does This Matter for Contractors?
This distinction can have a significant impact on how you interpret your Profit & Loss statement.
Imagine your company receives several large customer payments during one month. Your cash-basis P&L could show a large increase in revenue, making that month appear extremely profitable.
But those payments may actually relate to projects or work completed during previous months.
Accrual accounting can provide a clearer picture of the financial performance of the work performed during a particular period.
For contractors, this can be especially helpful when evaluating:
- Gross profit
- Job profitability
- Labor costs
- Material costs
- Monthly performance
- Project performance
- Overall business profitability
Which Is Better for Reviewing a Contractor’s P&L?
If your goal is to understand profitability, an accrual-basis Profit & Loss is generally the better place to start.
Accrual reporting helps answer an important question:
“Are we making money on the work we’re actually performing?”
However, cash flow is still extremely important.
A contractor can show a healthy profit on an accrual-basis P&L and still have difficulty paying bills because customers haven’t paid their invoices.
That’s why looking at profitability alone isn’t enough.
You need to understand both your profitability and your cash flow.
A Simple Way to Remember
Think about it this way:
Cash basis: When did the money move?
Accrual basis: When did the business activity happen?
Both methods provide useful information, but they answer different questions.
Your accrual P&L helps you understand how the business is performing.
Your cash flow and bank balances help you understand how much money is available to operate the business.
The Bottom Line for Contractors
If you’re a contractor trying to make better financial decisions, don’t look at your bank balance alone and don’t rely on a single report.
Use your accrual-basis Profit & Loss to understand profitability, then look at accounts receivable, accounts payable, bank balances, and cash flow to understand your company’s financial position.
The goal isn’t simply to know how much money came into the bank.
The goal is to understand whether your business is profitable, where you’re making money, and whether you have enough cash to keep building.
Need Help Understanding Your Contractor P&L?
If your Profit & Loss statement doesn’t make sense, you’re not alone.
Construction businesses have unique bookkeeping needs, and your financial reports should help you understand what’s happening in your business—not leave you with more questions.
Book a call today to learn how better construction bookkeeping can give you clearer numbers and more confidence in your business.