Choosing Between Cash and Accrual Accounting

There are two primary methods of accounting for a small business: cash basis and accrual basis. The difference is not just technical—it affects when you recognize income and expenses, which in turn affects your tax liability and your understanding of how the business is actually performing.

Under cash-basis accounting, you record income when you receive payment and record expenses when you pay them. It is simple, intuitive, and matches the way most people think about money. If you send an invoice in December and get paid in January, the income is recorded in January. Cash basis is available to most small businesses with average annual gross receipts under a certain threshold.

Under accrual-basis accounting, you record income when it is earned (when you send the invoice, not when you receive payment) and expenses when they are incurred (when you receive the bill, not when you pay it). Accrual gives a more accurate picture of profitability for a given period, because it matches revenue to the expenses that produced it, regardless of when cash moves.

For a business that carries inventory, accrual is generally required—matching the cost of goods to the period in which they are sold gives a truer picture of margin. For a service business with no inventory and simple billing, cash basis is often sufficient and far simpler to maintain.

The choice also has tax-planning implications. Under cash basis, you can sometimes shift income or expenses between years by timing when you send invoices or pay bills. Under accrual, that flexibility is limited because the timing of the transaction, not the payment, determines the year it is recognized.

If your business is growing and approaching the gross-receipts threshold, or if you are considering seeking financing, talk to us about whether a switch makes sense. Some businesses benefit from keeping books on an accrual basis for management purposes while filing taxes on a cash basis.