Cash vs. Accrual Accounting: Which One and Why It Matters

Two Ways to Count the Same Money

There are two methods of recording revenue and expenses in your books: cash basis and accrual basis. The method you pick changes how your financial statements look, how much tax you owe in a given year, and how you make decisions.

This is not an academic exercise. Pick the wrong method and you might think you are profitable when you are running out of cash, or you might pay taxes on money you have not collected yet.

Cash Basis Accounting

With cash basis, you record revenue when you receive payment and expenses when you pay them. Simple.

Example: You complete a $10,000 job on March 15. The client pays you on April 20. Under cash basis, that $10,000 shows up as revenue in April — the month you got paid.

Advantages

• Simple to understand and maintain. You look at your bank account, and your books roughly match.
• Tax timing advantage. You only pay taxes on money you have actually received.
• Better cash visibility. Your P&L reflects actual cash movement.

Disadvantages

• Does not show the full picture. You might have $50,000 in completed work that has not been paid. Cash basis says you earned nothing.
• Easy to manipulate. Delay sending invoices in December to push revenue to January. The IRS knows this trick.
• Harder to track profitability by job or project. Payments come in at different times than the work happens.

Accrual Basis Accounting

With accrual basis, you record revenue when you earn it (regardless of payment) and expenses when you incur them (regardless of when you pay).

Example: Same $10,000 job completed March 15. Under accrual, it is recorded as March revenue even though cash arrives in April. If you bought $3,000 in materials for that job in February, that expense is matched to March as well.

Advantages

• Accurate profitability picture. Revenue and expenses are matched to the period they belong to.
• Better for decision-making. You can see true margins on individual jobs and months.
• Required for larger businesses. If your average annual gross receipts exceed $29 million over three years, the IRS requires accrual.
• Lenders and investors expect it. If you ever need a loan or investment, they want accrual-based statements.

Disadvantages

• You pay tax on money you have not collected. That $10,000 job booked in March? You owe tax on it even if the client has not paid.
• More complex to maintain. Requires tracking receivables, payables, and adjusting entries.
• Can mask cash problems. You look profitable but your bank account disagrees.

Which Should You Use?

Use Cash Basis If:

• You are a sole proprietor or small LLC
• Annual revenue is under $1 million
• You have simple transactions (service-based, no inventory)
• You want simplicity and tax flexibility
• You do not carry significant receivables or payables

Use Accrual Basis If:

• You carry inventory
• You have significant accounts receivable (invoicing clients with payment terms)
• Your revenue exceeds $1 million and you need accurate job costing
• You plan to seek financing or investors
• You need to understand true profitability by period

The Hybrid Approach

Many small businesses use cash basis for taxes and run internal accrual reports for decision-making. Your accountant can maintain cash-basis books for the IRS while generating accrual-basis reports for you. This gives you the tax benefit of cash basis and the management insight of accrual.

The IRS Rules

The IRS generally allows small businesses with less than $29 million in average annual gross receipts to use cash basis. There are exceptions:

• C corporations (with some small business exceptions)
• Partnerships with a C corporation partner
• Tax shelters

If you carry inventory, recent tax law changes now allow more small businesses to use cash basis than before, thanks to the Tax Cuts and Jobs Act changes to Section 471.

How This Affects Your Decisions

Imagine it is December. You have had a great year. Under cash basis, you could delay invoicing a $20,000 job until January to reduce this year's taxable income. Smart tax planning.

But under accrual, that job was completed in December, so it is December revenue regardless. Your tax planning shifts to timing expenses, like prepaying January rent or buying equipment before year-end.

Understanding your accounting method is not just bookkeeping trivia. It directly impacts how you plan, how much tax you pay, and how clearly you see your business's health.

Making the Switch

You can change methods, but it requires filing Form 3115 with the IRS. The switch creates a Section 481(a) adjustment to prevent income from being counted twice or not at all. This is not a DIY project — work with your accountant.

The Bottom Line

Cash basis is simpler. Accrual basis is more accurate. Neither is universally "better." The right choice depends on your business size, complexity, and goals. Know which method you are using, understand what it shows and hides, and make sure your decisions account for the gaps.