Cash vs. Accrual Accounting: Which Should Your Business Use?

Cash accounting records income when money actually arrives and expenses when money actually leaves. It is simple, intuitive, and matches your bank account closely. Most very small businesses and sole proprietors start here because it requires the least judgment and is easy to maintain. The downside is that it can hide the real timing of business activity, especially if you invoice clients who pay slowly.

Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when cash changes hands. If you invoice a client in March for work done in February, accrual records the revenue in February. This gives a more accurate picture of what the business actually did in a given period and is required by GAAP for larger businesses.

Most small businesses can choose either method. Businesses with average annual gross receipts above the IRS threshold, currently in the tens of millions, are generally required to use accrual. Inventory based businesses often have to use accrual for inventory even if they use cash for everything else. Once you pick a method, changing it later requires IRS approval, so choose deliberately.

Cash works well for service businesses with simple cash in, cash out patterns and few unpaid invoices outstanding. Accrual is better for businesses that invoice clients, carry inventory, or want to see true profitability by period. Many businesses keep their internal books on accrual for management decisions and convert to cash for tax filing where allowed. A bookkeeper can help you set this up correctly from the start.