Cash vs. accrual accounting: What’s the difference?

Financial clarity is essential for every business.

Knowing what’s coming in and going out isn’t just good practice—it’s the foundation for choosing the right accounting method.  

The choice between cash vs. accrual accounting significantly impacts your tax obligations, affects how you manage your financial accounts, and determines the quality of financial insights you can rely on for critical business decisions. 

Most businesses use either cash or accrual accounting for tax reporting, although some may find a hybrid approach beneficial.

But beware—once you select a tax method, switching isn’t straightforward, and the IRS values consistency in your choice. So, which approach is best for your business? 

Let’s dive in to find out how each method works so you can make the best choice for your business’s financial future. 

Here’s what we’ll cover: 

What is cash basis accounting?

Cash basis accounting tracks your business’s actual cash flow.

Under this method, revenue is recorded when money is received, and expenses are recorded when paid.

This approach doesn’t account for accounts receivable or accounts payable until cash changes hands.

Because it’s straightforward, cash basis accounting is commonly used by smaller businesses with tight cash flows.

The main advantage? You won’t pay taxes on income until it’s received.

However, this method may not provide a complete financial picture—especially if you’re managing large receivables or payables, as these aren’t recorded until payment is made or received.

Advantages of cash basis accounting

Simplicity

The cash method versus accrual method debate often highlights simplicity as a major benefit.

Cash basis is straightforward, requiring minimal bookkeeping, and is ideal for small businesses without complex transactions.

Tax benefits

With cash basis accounting, taxes are paid only when income is received, potentially easing the tax burden during slower periods.

Cash flow transparency

Cash basis accounting provides a clear view of actual cash on hand, which is valuable for daily cash flow management.

Lower administrative costs

Due to its simplicity, cash basis accounting is usually more affordable to maintain, reducing administrative expenses.

Useful for seasonal businesses

Businesses with irregular income can benefit from cash basis accounting, which aligns tax payments more closely with their cash flow cycles.

Disadvantages of cash basis accounting

Incomplete financial picture

One of the primary differences between cash accounting versus accrual is that the cash basis doesn’t include unpaid receivables or payables, leading to a less comprehensive view of finances.

Challenges with scalability

As a business grows, cash-based accounting can become limiting, making the transition to accrual accounting necessary for greater accuracy.

Potentially misleading financials

Without including pending payments, cash basis accounting can misrepresent profit and loss, which may impact important financial decisions.

Limited insight for planning

Cash basis accounting may lack the detail needed for effective long-term budgeting and forecasting since it doesn’t account for unpaid receivables or payables, which can affect a business’s ability to plan accurately.

Investor and lender preferences

Investors and lenders often prefer a more detailed view of finances, which accrual accounting provides. This preference can impact a business’s access to credit or investment if cash basis accounting is used.

What is accrual basis accounting?

Accrual basis accounting records revenue and expenses when they are earned or incurred, regardless of when cash is actually received or paid.

This method captures the true economic activity of a business, offering a fuller picture of financial performance over time.

For example, if you complete a project for a client in February but don’t receive payment until April, the revenue from that project is still recorded in February.

By recognizing income when it’s earned, accrual accounting provides a more accurate reflection of financial health and business operations, making it the standard approach for businesses following Generally Accepted Accounting Principles (GAAP) or with average annual revenues of $25 million or more over three years.

Advantages of accrual basis accounting

Accurate financial overview: accrual accounting provides a complete view of finances by including receivables and payables, accurately matching revenue and expenses to their periods.

This ensures financial reports reflect true business performance.

Compliance with GAAP

As GAAP-compliant, accrual accounting meets standards required for businesses with investors or loans, boosting credibility in financial reporting and ensuring regulatory compliance.

Enhanced long-term planning

Accrual accounting supports accurate forecasting and strategic planning by aligning revenue and expenses to the actual period they occur, helping businesses make informed, long-term decisions.

Transparency for stakeholders

This method gives investors and lenders a transparent picture of financial health by including all assets, liabilities, and transactions, which builds trust and reduces financial surprises.

Smoother growth transition

Starting with accrual accounting can ease the complexity of switching from cash basis as you grow, aligning with standard reporting and investor expectations from the start.

Improved comparison across periods

By matching income and expenses to their correct periods, accrual accounting allows for consistent comparisons, making it easier to identify trends and make adjustments.

Comprehensive balance sheet

Accrual accounting’s inclusion of all assets, liabilities, payables, and receivables creates a full picture of the financial position, which is essential for meeting cash flow needs and managing liabilities.

Disadvantages of accrual basis accounting

More complex to manage

Accrual accounting requires detailed record-keeping, often needing more time, expertise, or even a professional to handle properly.

For small businesses, this extra effort can add costs and administrative overhead.

Cash flow clarity challenges

Accrual accounting may show profitability on paper, even if cash hasn’t yet been received.

This can make it harder to gauge actual cash available and may require careful cash flow monitoring.

Tax obligations on unpaid revenue

With accrual accounting, you may have to pay taxes on revenue you haven’t received yet.

This can put a strain on cash reserves, especially for smaller businesses managing tight budgets.

Higher risk of internal fraud

The added complexity of accrual accounting can increase opportunities for internal fraud.

Strong internal controls and oversight are essential to manage this risk effectively.

Can be costly

Keeping accurate accrual-based records often involves higher costs.

Small businesses might need extra software or a bookkeeping service, which can be a significant investment over time.

Time-consuming

Tracking income and expenses as they occur requires more time than cash accounting, and as transactions grow, so does the bookkeeping workload.

For busy business owners, this can be a challenge.

Unexpected tax bills

If you’re a cash-basis taxpayer reviewing only accrual reports, you might face surprise tax liabilities at year-end.

This happens when accrual records don’t reflect the cash basis used for tax filings.

Differences between cash and accrual accounting  

Which is better, cash or accrual accounting?

Here is a table describing the main differences between cash basis vs. accrual basis accounting to help you decide on an accounting method for your business: 

Variable	Cash basis accounting	Accrual basis accounting
Timing	Records transactions only when cash is exchanged (when payment is received or paid).	Records revenue and expenses when they are earned or incurred, regardless of when cash is actually exchanged.
Complexity	Simple, immediate, and easy to manage, often with minimal bookkeeping requirements.	Requires more detailed tracking, especially of receivables and payables, and is generally more complex to maintain.
Ideal for	Small businesses, freelancers, and sole proprietors with straightforward transactions.	Larger companies, businesses with inventory, and those seeking a long-term financial view or needing investor support.
View of financial health	Provides a short-term view of cash flow, showing only the current cash balance.	Offers a comprehensive view of financial health by accounting for all income and expenses, even if unpaid.
Cash flow management	Easier to track available cash since only cash transactions are recorded.	May show profitability even if cash is unavailable, requiring more careful monitoring of actual cash flow.
Legal requirements	Generally allowed for small businesses below a revenue threshold and for tax deferral on unpaid income.	Required by law for larger companies, public companies, and those following GAAP or IFRS standards.
Tax implications	Taxes are paid only on income received, potentially reducing the tax burden in low-cash months.	Taxes may be due on earned revenue even if payment hasn’t been received, potentially impacting cash reserves.
Example	Similar to managing personal finances by tracking cash in and out with a banking app.	Like using a budgeting app that logs all expected income and expenses for a complete financial picture.
Pros	Simpler to manage, provides real-time cash flow insight, lower bookkeeping costs.	More accurate long-term view, supports financial planning, meets investor and lender requirements.
Cons	Doesn’t show full financial commitments; may miss unpaid revenue or expenses.	More complex, can be costly, requires careful cash management to avoid liquidity issues.

Accrual vs. cash basis examples

To understand how accrual accounting vs. cash accounting impact your financial statements, let’s look at a simple example of a marketing agency’s monthly transactions.

Imagine the following transactions occur in April:

• You invoice a client $3,000 for a completed project.
• You receive a bill for $500 for freelance design work done this month.
• You pay $100 for a software subscription billed last month.
• You collect $800 from a client for a project invoiced in March.

Using cash basis accounting

With cash basis accounting, you only record transactions when money actually moves.

For April, this would look like:

Revenue: $800 (received from March’s invoice).

Expenses: $100 (software subscription payment).

Your cash-basis profit for April would be $700 ($800 income – $100 expense).

Using accrual basis accounting

Accrual accounting records income and expenses as they occur, regardless of when cash is exchanged.

For April, you would report:

Revenue: $3,000 (invoiced in April).

Expenses: $500 (freelancer bill for April).

Under the accrual method, your profit for April would be $2,500 ($3,000 income – $500 expense).

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Key takeaway

As you can see, cash and accrual accounting result in different profit figures for the same period.

Cash versus accrual profit and loss can impact how you view your financial health—cash basis shows actual cash flow, while accrual provides a broader view of revenue and expenses as they’re incurred.

This difference can significantly impact your financial statements.

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How cash vs. accrual accounting affects your taxes

One of the biggest differences between cash and accrual accounting is how each method impacts the timing of taxable income and expenses.

This can significantly affect your tax obligations, especially as the calendar year ends.

Tax impact of cash accounting

With cash basis accounting, you’ll only pay taxes on income that’s physically in your bank account.

For example, if you invoice a client in December but don’t receive payment until January, that income would count toward the following tax year, potentially lowering your taxable income for the current year.

Tax impact of accrual accounting

Take the same scenario within the accrual accounting method.

If you invoice a client in December, that income is included in your taxable income for that year, even if you receive payment in January.

Accrual accounting aligns your tax obligations with your actual business activity, but it also means you could end up paying taxes on income you haven’t yet received.

State tax regulations

In addition to federal tax rules, some states have specific requirements around accrual versus cash accounting for certain industries or business types.

Businesses should check their state’s regulations to ensure compliance with both federal and state tax laws, as this may influence which accounting method is more suitable.

Cash or accrual accounting: Which one is better for your business? 

Choosing between cash and accrual accounting depends on your business’s size, complexity, and future goals. Here are some key factors to consider: 

Factor	Cash accounting	Accrual accounting
Business size	Small businesses, freelancers, sole proprietors	Growing or larger businesses with complex transactions
Complexity	Simple and easy to maintain	Requires tracking receivables, payables, and financial periods
Financial insight	Shows real-time cash flow but lacks a long-term view	Provides a complete financial picture, aligning revenue and expenses
Tax impact	Taxes are only paid on income received	Taxes may be owed on earned revenue, even if payment hasn’t arrived
Growth readiness	Best for businesses with simple operations	Preferred for businesses seeking investment, loans, or future expansion
Regulatory compliance	Allowed for small businesses; not GAAP-compliant	Required for businesses earning $25M+ or following GAAP

Still unsure?

Some businesses use a hybrid approach internally while maintaining a cash or accrual basis for tax reporting.

Consulting an accountant can help you make the best decision. 

Cash and accrual accounting: The hybrid method 

The hybrid method combines cash and accrual accounting, offering businesses flexibility in how they track finances internally.

Though it isn’t recognized for tax purposes, this approach can provide helpful insights for managing different areas of the business. 

For instance, a business might use cash accounting for day-to-day transactions to keep a simple record of cash flow while using accrual accounting to monitor inventory or larger projects.

This way, the hybrid method balances real-time cash tracking with a broader financial view, offering the best of accrual vs. cash reporting and giving business owners a fuller picture of their profitability. 

Because it blends two systems, the hybrid method requires consistent management to avoid errors.

Collaborating with an accountant can help ensure smooth and accurate reporting so your business remains compliant and your financial insights stay reliable. 

Best practices for using cash or accrual methods 

Choosing the right accounting method is just the first step—using it effectively will help you manage your finances accurately.

Here are some best practices for making the most of either cash or accrual accounting: 

Stay consistent with your method 

Once you’ve chosen either cash or accrual accounting, apply it consistently across all transactions. Switching between methods can lead to confusion, errors, and compliance issues.

If you need to change methods, work with an accountant to ensure a smooth transition. 

Monitor cash flow closely, especially with accrual accounting 

Accrual accounting provides a comprehensive financial picture but doesn’t show real-time cash availability. Keep a close eye on cash flow to avoid any shortfalls.

Cash accounting users should also monitor cash flow to make sure they’re covering immediate financial needs. 

Use accounting software to simplify your process 

Accounting software can make both cash and accrual accounting easier by automating entries, tracking receivables and payables, and giving you real-time insights.

Solutions like Sage Intacct or Sage 50 can help keep your finances organized and reduce manual errors. 

Keep accurate records for tax time 

For cash basis users, record income and expenses only when cash is exchanged.

For accrual users, carefully track receivables and payables to match tax obligations accurately.

Consistent record-keeping helps with compliance and simplifies tax season. 

Plan with long-term goals in mind 

Cash accounting may give a partial view of long-term profitability, so consider moving to accrual accounting as your business grows.

This is especially important if you’re planning for investment, expansion, or complex projects. 

Get professional advice for complex situations 

Depending on your accounting method, certain transactions—like inventory or long-term contracts—may need special handling.

Consulting an accountant can help ensure these areas are managed correctly, especially if you’re using a hybrid approach. 

Re-evaluate as your business evolves 

The right accounting method for a small startup may not be the best choice as your business grows. Regularly assess whether your current method still aligns with your operations, compliance needs, and future plans. 

Cash basis vs. accrual basis: How accounting software can help  

As financial management becomes more complex, accounting software like Sage Intacct can simplify cash and accrual accounting.

For cash accounting, it automates cash flow tracking, providing real-time visibility into your financial position to support everyday decisions. 

For accrual accounting, Sage Intacct streamlines the tracking of receivables and payables, offering a complete financial view.

The software integrates seamlessly with other business tools, enabling more accurate analysis, forecasting, and strategic insights as your business grows. 

Whether you’re focused on cash flow or long-term performance, Sage accounting software supports financial control at every stage. 

Cash vs. accrual accounting FAQs 

Is GAAP accrual or cash basis? 

GAAP only allows the accrual basis of accounting.

Under GAAP, income and expenses are recorded when they’re earned or incurred, not necessarily when cash changes hands.

This approach provides a more accurate picture of a business’s financial health by aligning revenue and expenses with the period they relate to rather than the timing of cash flow. 

How to switch from cash to accrual accounting 

To switch from cash to accrual accounting, start by adjusting your records to include accounts receivable, accounts payable, prepaid expenses, and unearned revenue.

Update your financial statements to reflect income and expenses when they’re earned or incurred, not when cash changes hands. 

You’ll also need to file IRS Form 3115 to request approval for the change.

This process can be complex, so working with an accountant can help ensure your records are accurate and compliant with accrual standards.