Cash versus accrual accounting—which method is best for your business?

Financially, knowing what’s coming in and going out is more than just good practice—it’s the foundation of choosing the right accounting method for your business: cash or accrual?

The method you choose will shape your tax obligations, impact your financial account management, and determine the quality of the financial insights you rely on for critical decisions.

Most businesses use cash or accrual accounting for tax reporting, while some take a hybrid approach.

But be careful—once you choose a tax method, it’s not easy to switch, and the IRS loves consistency. So, which is best for your business?

Here’s what we’ll explore

Cash versus accrual accounting: What’s the difference?

The main difference is timing Cash accounting records transactions when cash changes hands, while accrual accounting records revenue and expenses when earned or incurred, regardless of payment.

• Cash accounting: revenue and expenses are recorded only when cash changes hands—when you receive money or make payments.
• Accrual accounting: revenue and expenses are recorded when earned or incurred, regardless of when payment is made.

Cash accounting is more straightforward but may not give you a complete picture of your financial health.

On the other hand, accrual accounting provides a more comprehensive view but requires more effort and careful cash-flow management.

Let’s consider cash and accrual accounting in terms of what you might be doing to balance your household budget.

Cash accounting is like managing your personal finances with a mobile banking app.

• You only count money when it hits your account, like getting that instant notification when money lands.
• Expenses? Same thing—those only show up when the cash leaves your account, like when you tap to pay for your morning coffee. It’s simple, real-time, and easy to track your available balance.

On the other hand, accrual accounting is more like managing your finances with a budgeting app.

• Even if your money hasn’t hit yet, or you haven’t paid your bills, you still log those transactions to see a complete picture of your financial commitments.
• It gives you a more accurate view of what you’ve earned and spent, but you must stay on top to avoid running low on actual cash.

So, picking between cash and accrual accounting is about deciding how detailed you want to be in tracking your finances and whether you’re focused on the here-and-now (cash) or taking the big-picture view (accrual).

Both methods are helpful, but choosing the right one for your business can help avoid headaches down the road.

What is cash basis accounting?

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

Revenue is recorded when money is received, and expenses are recorded when they are paid.

This method does not consider accounts receivable or payable until the cash is exchanged.

• Cash basis accounting is straightforward and often used by smaller businesses with tight cash flows.
• The main advantage is that you don’t pay taxes on income until it’s received. However, it may not reflect the whole financial picture, particularly when large receivables or payables are involved.

The advantages of cash basis accounting

• Simplicity: easier to manage and understand.
• Tax benefits: taxes are paid only when revenue is received.
• Cash flow transparency: offers a clear view of actual cash on hand.

The disadvantages of cash basis accounting

• Incomplete financial picture: it doesn’t account for receivables or payables.
• Limited use: not ideal for businesses with significant inventory or long-term projects.

What is accrual accounting?

Accrual accounting records revenue and expenses when they are earned or incurred, regardless of when cash is exchanged.

For example, income is recorded when a project is completed, not when the payment is received.

This method is required by businesses that follow Generally Accepted Accounting Principles (GAAP) or have revenues over $26 million.

Advantages of accrual basis accounting

• Accurate financial overview: gives you a comprehensive view of revenue and expenses, including receivables and payables.
• Compliance with GAAP: necessary for businesses with investors or loans.
• Better long-term financial planning: supports forecasting and strategic decision-making.

Disadvantages of accrual basis accounting

• Complexity: requires more time, effort, and possibly specialized staff.
• Cash flow management: it may show profitability even when cash is unavailable.
• Tax obligations: you may pay taxes on revenue that hasn’t been received yet.

Cash or accrual accounting?

For small businesses with straightforward operations, cash accounting often makes sense.

It’s simple to manage and gives a clear snapshot of cash flow—ideal for businesses focused on short-term financial management.

However, cash accounting might not give you the total financial picture you need to plan if your business has long-term contracts, large inventories, or growth plans.

Accrual accounting becomes essential as your business scales and operations become more complex.

It provides a more comprehensive view of your financial health, capturing revenues and expenses as they occur rather than when cash changes hands.

This method offers better insights for decision-making and strategic planning, helping you track profitability and manage performance over the long term.

Remember, even with accrual accounting, maintaining a close watch on cash flow is critical to avoiding liquidity challenges.

For tax purposes, companies with revenue over $26 million in the previous 3 years must use accrual.

Lei Han, associate professor at the Department of Accounting at Niagara University, says: “Most mom-and-pop shops will use cash accounting.

“However, if you’re still small but think you will grow to beyond $26 million revenue quickly, you may consider using accrual accounting now because it takes cost and effort to transition to it—including filing an IRS form and getting approval.”

You must also use the accrual basis if you want to use GAAP. Businesses with investors or loans tend to use the accrual basis in their financial statements because most lenders require GAAP.

How technology can help with cash and accrual accounting

The complexity of managing financials grows as your business scales. This is where technology can make a real difference.

Accounting software like Sage Intacct streamlines cash and accrual accounting, providing powerful tools for managing your finances more efficiently.

Sage Intacct automated workflows and real-time reporting can simplify cash accounting and help you manage cash flow with minimal effort.

It takes the manual guesswork out of tracking transactions and gives you clear visibility into your current financial position—perfect for managing short-term operations.

Sage Intacct robust features make accrual accounting more manageable.

Using the accrual basis helps you track what’s owed in both directions, giving a more complete view of your company—one that you can view in advanced accounting software dashboards.

Sage Intacct allows you to automatically track receivables, payables, and expenses, giving you an accurate financial snapshot at any given time.

The software integrates seamlessly with other business systems, driving deep insights for strategic decision-making.

Sage Intacct easily handles multi-entity consolidations and complex reporting making it an ideal choice for scaling businesses looking to maintain financial control without increasing the administrative burden.

With Sage Intacct, you get the flexibility and insights needed to manage cash flow and overall financial performance—whether you’re focused on short-term gains or long-term growth.

This allows for more accurate analysis, forecasting, and strategy.

This is usually key in a growing organization with lots of moving parts, including long-running projects and credit offered to and from customers and suppliers.

One downside of accrual accounting is that it’s more complex than cash accounting

Accrual accounting requires more time, effort, and possibly specialized staff.

You’ll need to monitor completed work and advance payments and track accounts payable, receivable, and accrued liabilities.

Accrual accounting also makes it harder to track cash flow.

Your business might look profitable on paper, but your bank account could be empty.

To avoid cash shortages, many companies use accrual for taxes but keep their internal books on a cash basis.

You might even owe taxes on income you haven’t received yet, so careful planning is critical to covering your tax bill.

Lei Han explains, “Accrual gives a more accurate picture, especially when paired with careful cash-flow monitoring. But you need more people to record and analyze.

“In a company with long-term projects—like construction—it takes professional judgment to assess how much work has been done and recognize the correct revenue and expenses.”

FAQs

Q: Can I switch from cash to accrual accounting?

A: Yes, you can switch from cash to accrual accounting, but you’ll need approval from the IRS by filing Form 3115.

It’s advisable to consult with a tax professional to ensure a smooth transition and compliance with all regulations.

Q: Which accounting method is better?

A: It depends on your business needs.

Cash accounting is simpler and may be suitable for small businesses with straightforward transactions and focusing on short-term cash flow.

Accrual accounting gives a more accurate financial picture, which benefits long-term planning and companies with more complex operations.

Q: How does inventory affect my choice of accounting method?

A: If your business maintains inventory for sale, the IRS generally requires you to use accrual accounting for purchases and sales of merchandise.

This method accurately matches income with the cost of goods sold, giving a clearer financial picture.

Q: Are there tax implications when choosing between cash and accrual accounting?

A: Yes, there are. Under accrual accounting, you might owe taxes on revenue you’ve earned but haven’t yet received, impacting your cash flow.

Cash accounting may offer short-term tax benefits by recognizing income only when cash is received.

Q: Is accrual accounting required under GAAP?

A: Yes. Generally Accepted Accounting Principles (GAAP) require using accrual accounting because it accurately represents a company’s financial position.

This is important if your business seeks external financing or plans to attract investors.

Editor’s note: this article was originally published in April 2023 and has been updated for relevance.