Accounting for Subscription Boxes: Cash vs. Accrual Methods

After you start your business and begin operations, you’ll need to decide on how you’re going to account for your business activity. And by activity, we mean revenue.

Cash vs Accrual Basis Accounting

After you start your business and begin operations, you’ll need to decide on how you’re going to account for your business activity.

And by activity, we mean revenue.

There are two primary methods of accounting: the cash basis and the accrual basis. Each method has its advantages and disadvantages.

The cash method is simpler, but does not give an accurate depiction of your business’ actual economic performance. The accrual method requires more work, but gives a more accurate depiction of your business’ profitability from month to month.

Below is a discussion of each, with some examples to illustrate the differences between these two methods of accounting.

The cash method is simpler, but does not give an accurate depiction of your business’ actual economic performance. The accrual method requires more work, but gives a more accurate depiction of your business’ profitability from month to month.

Method #1: The Cash Method

The cash method of accounting records only the cash events that occur.

Let’s look at an example:

When you receive cash from a customer, you would record this as revenue when the cash is received. Assume you sold 100 six month subscriptions at $38.95 per month and received the cash in the month of December. Under the cash method, you would recognize all $23,370 of this (100 customers at 6 monthly subscriptions each at $38.95 per month) as revenue in December when the cash is received.

Why is this important? Under the cash method, it doesn’t matter that you haven’t yet fulfilled all six months of this cohort’s subscriptions.

On the expense side, you record expenses when the cash leaves your bank account; it doesn’t matter if that cash outflow paid for an expense actually incurred in a prior period of time.

For example, if you receive a $100 utility bill in January for December utility services, you would record this $100 expense in January when the bill is paid and the cash leaves your bank account.

As you can see from these examples, the recording of your business activity is relatively straightforward under the cash method.

However — and this is a big however —  if you want to examine the monthly profitability of your business you would be seeing misleading results. 

  • First, your Profit and Loss would show $23,370 in revenues in December (from this particular cohort), and nothing in the five following months.
  • Second, you would show $100 in expenses in January, despite the fact that this was for December services.

How would we account for this then?

The accrual method matches the underlying economic activity with the appropriate time period.

Method #2: The Accrual Method

Unlike the cash method, the accrual method of accounting records the revenues and expenses of a business during the period of time they are either earned (revenue) or incurred (expenses).

Let’s return to the revenue example discussed above.

Assuming the December box was shipped in the month of December, only $3,895 of the cash received would be recognized as revenue in the month of December (one sixth of $23,370) on your Profit and Loss statement. The remaining $19,475 would be placed on the Balance Sheet in a liability account.

As you ship this cohort their monthly boxes, you would record a journal entry to recognize another month’s worth of revenue. After the final box is shipped to these customers, you will have no liability left on the Balance Sheet and you will have recognized the revenue from these customers in the appropriate month.

On the expense side, let’s look back at the example given above of the $100 December utility bill not received until January.

Under the accrual method, you would record a journal entry to show the incurrence of $100 in utility expenses in December on the Profit and Loss statement. This $100 would also be shown on the Balance Sheet as a payable to the utility provider. When the cash leaves your bank account in January, you would apply the cash payment to the liability recorded on the Balance Sheet to extinguish it.

By accounting for the above two transactions using the accrual method you get a better idea of how profitable your business was during December and January. The profitability of these two months are not skewed based on the timing of the cash flows.

The Best Method? What are you goals. 

Based on the examples above, you can see that the cash method of accounting is much more straightforward than the accrual method. However, investors and creditors rely on accrual method financial statements when evaluating a business. This is because the accrual method better depicts the actual profitability of the business.

Questions? Start a conversation below.

This guide was collaborated on with Rylan Wirkkala, CPA. Find him in the Resources section.

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About Jesse Richardson

Jesse Richardson is an author, educator and co-founder of several successful subscription businesses. He focuses on building engaging communities and has been described as "insanely customer centric." Find him in the Subscription School group or at his blog.

6 Responses

  1. Thank you for this! I love how you used the example in both to make it straight forward and easy to understand. I will definitely start keeping better track now that I know a better way to do it!

  2. HI Jesse,

    Happy Monday!

    I’ve really learned so much from your website Subscription School. Thank you for making this important information available.

    I’m specifically looking for return policy examples. Is this something that you can help me with? I must be missing it on your site.

    Best,

    Hallie Sculler
    Happy Being

    P.S. Launch page is being revised.

  3. Great summery. I would like to transition to the Accrual Method. Are there any proven platforms out there that can handle Cratejoys regular monthly accounting and prepaid subscriptions easily? I don’t know where to begin in the transition. I’ve been operating 100+ subscriptions, and started 3 months ago. Things are still fairly new.

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