Cash vs Accrual Accounting: A Decision Checklist for Small Business
Cash and accrual accounting compared side by side, the same transaction recorded both ways, a decision checklist that produces an actual answer, what it means for your tax timing, and the five mistakes that cost people money.
This article is for educational and informational purposes only and does not constitute financial, tax, legal, or accounting advice. Groundwork is not a licensed financial advisor, accountant, or attorney. Before making decisions, consult a qualified professional.
The difference is when you record money, not how much. Cash accounting records revenue when payment lands in your account and expenses when money leaves it. Accrual accounting records revenue when you earn it and expenses when you incur them, regardless of when cash moves. Invoice a client in March and get paid in May: cash basis records it in May, accrual records it in March. Cash is simpler, tracks your bank balance closely, and suits most small service businesses. Accrual is more accurate about profitability, is required for larger businesses in most jurisdictions, and is what lenders and buyers expect to see. The short decision: if you hold inventory, extend credit to customers, or plan to raise money or sell, use accrual. If you are a small service business paid close to when you work, cash is usually the better trade. The comparison table and the decision checklist below work through it properly.
- Cash vs accrual, side by side
- The same transaction, recorded both ways
- Cash accounting: how it works and who it suits
- Accrual accounting: how it works and who it suits
- The decision checklist
- What this means for your tax bill
- The five mistakes that cost people money
- Switching from one to the other
- Frequently asked questions
Most explanations of this choice describe two accounting methods and leave you to work out which one applies to you. That is the wrong way round, because for a lot of businesses the choice is already made by rules you may not know about, and for everyone else it comes down to about four questions.
So this guide leads with the comparison, shows the same transaction recorded both ways so the difference stops being abstract, then gives you a checklist that produces an actual answer.
Cash vs Accrual, Side by Side
| Cash basis | Accrual basis | |
|---|---|---|
| Revenue recorded | When payment arrives | When the work is done or goods delivered |
| Expenses recorded | When you pay them | When you incur them |
| Shows profitability | Poorly. Timing distorts it | Accurately, period by period |
| Shows cash position | Directly. It is your bank balance | Not directly. Needs a separate cash flow view |
| Complexity | Low. Follow the bank account | Higher. Tracks receivables and payables |
| Handles inventory | Badly | Properly |
| Lenders and buyers | Often want it converted | What they expect |
| Best for | Small service businesses paid near the work | Inventory, credit terms, growth, outside money |
Scroll sideways on a phone to see both columns.
The Same Transaction, Recorded Both Ways
Abstract definitions are where this gets confusing. Here is one ordinary sequence, recorded under each method.
The situation: you finish a 4,000 project on 20 March. You invoice the same day, on 30-day terms. The client pays late, on 12 May. Meanwhile you paid a 600 subcontractor on 5 April for work they did in March.
Cash basis
March: nothing. No money moved.
April: 600 expense.
May: 4,000 revenue.
Accrual basis
March: 4,000 revenue and 600 expense. Profit 3,400.
April: nothing new.
May: nothing new. Cash arrives, profit was already booked.
Look at what cash basis does to March. You did the work, you earned 4,000, and your books say you had a month with no revenue and no costs. Then May looks like a spectacular month you did nothing to earn. Neither picture is true, and if you were deciding in April whether you could afford to hire, you were reading a broken instrument.
Accrual puts the revenue and its matching cost in the month the work happened, which is the entire point of the method. The trade-off is that your accrual profit and loss statement will happily show a profitable March while your bank account sits empty until May, which is why accrual users need to watch cash separately.
Aziz's take: The version of this that actually bites is seasonal. A business that invoices heavily in December and gets paid in January will, on cash basis, report a thin December and a triumphant January, every year, forever. You end up making decisions against a calendar that is permanently one month out of phase with your real trading. If your payment terms are long enough that this happens to you, that alone is a reason to move to accrual, regardless of what any threshold requires.
Cash Accounting: How It Works and Who It Suits
Cash accounting follows your bank account. Money in is revenue on the day it arrives; money out is an expense on the day it leaves. That is nearly the whole method, which is its great advantage.
What it does well. It is simple enough to run without training. It tells you your cash position at a glance, because the books and the bank say the same thing. And it defers tax on money you have not received yet, which genuinely helps a business waiting on slow payers.
Where it misleads. It cannot tell you whether a month was actually good. It hides money owed to you and money you owe. It handles inventory badly, because stock bought in one period and sold in another lands in the wrong place entirely. And it produces no meaningful balance sheet, since receivables and payables are invisible to it.
It suits you if you are a service business paid close to when you work, you hold no inventory, you are not extending or receiving significant credit, and nobody outside the business needs to read your accounts.
Accrual Accounting: How It Works and Who It Suits
Accrual records revenue when it is earned and expenses when they are incurred. Its organising idea is the matching principle: a cost belongs in the same period as the revenue it helped produce. That is why the subcontractor in the example above lands in March alongside the project, not in April when they were paid.
What it does well. It shows real profitability, period by period. It surfaces what you are owed and what you owe. It handles inventory correctly. It produces the balance sheet lenders, investors, and buyers expect, and it is what any accountant will assume you are on above a certain size.
Where it costs you. It takes more work, since you are tracking invoices and bills rather than just bank movements. It can show a profit while your account is empty, which is exactly how profitable businesses run out of money. And it can put you in the position of paying tax on revenue you have not yet collected.
It suits you if you hold inventory, invoice on terms, have a growing team, are approaching whatever threshold applies in your jurisdiction, or intend to raise money or sell the business.
The mechanics underneath both methods are the same: every transaction still gets recorded twice, and both use the same list of categories. Our guides to double-entry bookkeeping and to building a chart of accounts cover that layer, which sits below this choice rather than beside it.
The Decision Checklist
Work down this list. The first yes in the top section settles it, because these are the cases where accrual is either required or so strongly indicated that the choice is not really open.
Any yes here means accrual
- Do you hold inventory or stock you buy before you sell?
- Are you above the revenue threshold that mandates accrual in your jurisdiction?
- Do you need audited accounts, or accounts a lender or investor will read?
- Are you planning to raise money or sell the business in the next few years?
- Do you have significant deferred revenue, such as annual plans paid upfront?
All yes here means cash is fine
- Are you a service business with no inventory?
- Are you usually paid within days or a couple of weeks of the work?
- Is your revenue comfortably under the threshold that would force accrual?
- Are your accounts read only by you and your tax filing?
- Is your trading roughly even across the year, without a seasonal invoicing lump?
If you land in neither group cleanly, the tiebreaker is what you want your reports to tell you. If the question you ask most often is "can I afford this right now," cash serves you. If it is "is this business actually profitable," you need accrual.
What This Means for Your Tax Bill
The method changes when income and expenses fall, which changes which tax year they land in. It does not change what you ultimately owe over the life of the business. Over a long enough horizon the two converge, and the difference is timing rather than total.
Timing still matters. Cash basis defers tax on unpaid invoices, which helps if customers are slow. Accrual can leave you taxed on revenue you have not collected, which is uncomfortable in a year of long receivables. And near a year end the two methods can produce materially different bills for the same trading.
Beyond that, the rules are jurisdiction-specific and they change: who is permitted to use cash basis, what the revenue thresholds are, which entity types are excluded, and how a switch must be handled are all local questions with real consequences for getting them wrong. Your accountant is the right source for your situation, and this is a case where an hour of their time is straightforwardly worth it. Our guide to small business tax deductions covers the adjacent ground, and the complete guide to small business finance puts this decision in context with the other systems it touches.
The Five Mistakes That Cost People Money
- Reading accrual profit as available cash. The most expensive error in this whole area. An accrual profit and loss statement showing a strong quarter tells you nothing about whether you can make payroll. Run a cash flow view alongside it, always.
- Using cash basis with long payment terms. If you invoice on 60 or 90 days, cash basis reports your business roughly one quarter out of phase with reality, permanently.
- Mixing the two. Recording revenue on one basis and expenses on the other produces numbers that describe nothing. Whichever you pick, apply it to both sides.
- Switching casually mid-year. A change of method is a formal event in most jurisdictions, usually with a required adjustment and sometimes needing permission. Doing it informally makes your year-end unreconcilable.
- Assuming your software already handles it. Most accounting packages can report on either basis, and the default is not always the one you filed under. Check which basis your reports are actually being generated on before you rely on them.
Switching From One to the Other
Businesses usually move from cash to accrual as they grow, and rarely the other way. The sequence that keeps it clean:
- Confirm with your accountant whether the switch requires permission or a filing where you are, and whether a transitional adjustment applies.
- Move at the start of a tax year, never mid-year, so no period is split across two methods.
- Before the changeover, list every invoice you have raised but not been paid for, and every bill you owe but have not paid. These are the items the two methods treat differently and the ones that need an opening adjustment.
- Set your accounting software's reporting basis explicitly rather than trusting the default.
- Run the first period on the new basis and compare it against what the old basis would have shown, so you understand the difference before you make decisions on it.
Expect the first accrual year to look strange, because revenue you already collected in cash terms may not appear as revenue again, and work you have done but not been paid for shows up as profit before the money exists. That is the method working correctly, not an error.
Frequently Asked Questions
