Cash Basis vs. Accrual Accounting: Which Should Your Small Business Use?
- Quan Chhieng
- May 28
- 6 min read
Updated: Jun 10
Cash basis accounting records income when you receive payment and expenses when you pay them. Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when cash actually changes hands.
For most small businesses under $25 million in annual revenue, cash basis is simpler and sufficient — but accrual gives a more accurate picture of financial health as you grow.
Here is how to think through which method is right for your business.
What Is Cash Basis Accounting?
Cash basis accounting records transactions when cash moves. If you send a client an invoice on March 31 but they pay you on April 15, that income shows up in April under cash basis — not March.
Example: A freelance graphic designer finishes a logo project on November 30 and sends an invoice for $2,000. The client pays on December 14. Under cash basis, the $2,000 is December income.
This method is simple, intuitive, and closely mirrors your bank account. For tax purposes, cash basis also gives you some timing flexibility — if you need to defer income or accelerate expenses in a given tax year, it is easier under cash basis.
Who it works well for:
Sole proprietors and freelancers
Service businesses with straightforward, quick-turnaround projects
Businesses with minimal inventory
Companies generating less than $1-2 million annually
What Is Accrual Accounting?
Accrual accounting matches revenue to the period it was earned and expenses to the period they were incurred — regardless of cash flow timing.
Under accrual, if you invoice a client $5,000 in March, that revenue is recorded in March even if the client does not pay until May. Similarly, if you receive an electric bill in December but do not pay it until January, the expense hits December.
Example: A small construction company builds a deck in August and invoices $15,000. Under accrual, all $15,000 is revenue when the work is completed and invoiced — not split based on when payments arrived.
Who it works well for:
Businesses with significant accounts receivable
Companies with inventory
Businesses with complex contracts or long project timelines
Companies planning to grow, raise money, or seek financing
Which Method Gives a More Accurate Picture of Your Business?
Accrual gives a more accurate picture of business performance — but that does not automatically make it better for every small business.
The problem with cash basis: a profitable month on paper can look terrible if your big clients have not paid yet. And a slow month can look great if you collected a bunch of old receivables. This makes it harder to evaluate true performance trends.
Accrual smooths this out by matching revenue to the month it was earned. If you did $80,000 in work in October, accrual shows $80,000 in October revenue even if half your clients take 60 days to pay.
That said, accrual comes with its own trap: you can show a healthy profit while your bank account is nearly empty, because you have earned revenue that has not been collected yet. Businesses on accrual need to track cash flow separately from their P&L.
What Does the IRS Require?
Businesses with average annual gross receipts of $25 million or less are generally permitted to use cash basis accounting. Businesses above that threshold are generally required to use accrual.
Important exceptions:
C corporations may have additional requirements
Businesses with inventory may need to use accrual for inventory-related items even if they use cash basis otherwise
Tax shelters are prohibited from using cash basis regardless of size
The IRS does not allow you to switch accounting methods without formal approval. You will need to file Form 3115 — Application for Change in Accounting Method.
Can You Use Different Methods for Taxes vs. Internal Reporting?
Yes — this is actually common. Some businesses use cash basis for their tax return but maintain accrual-basis books internally so their financial reports are more meaningful.
At WSC Accounting, we help clients maintain clean accrual-basis books while still filing on a cash basis for taxes. The two do not have to be in conflict.
How Do You Switch Accounting Methods?
Talk to your accountant first — switching methods has tax implications that need to be modeled before you make the change
File Form 3115 with the IRS to request an accounting method change
Make a Section 481(a) adjustment — this one-time entry accounts for the difference between the old and new method
Update your chart of accounts to add accounts receivable, accounts payable, and accrued liabilities if moving to accrual
Configure your accounting software — QuickBooks Online and Xero both support both methods
Which Should Your Small Business Use?
Start with these questions:
Do your clients pay you immediately, or do many pay 30-90 days later? If you have significant receivables, accrual gives a more accurate picture.
Do you carry inventory? If so, accrual is generally required for inventory even if you use cash basis otherwise.
Are you seeking a bank loan or investor funding? Lenders typically want accrual-basis financials.
Is your business growing rapidly? Accrual scales better as complexity increases.
Are you a solo service provider with simple transactions? Cash basis is probably fine.
If you are unsure, start with a conversation with your accountant. The right method depends on your specific industry, size, growth trajectory, and tax situation.
Ready to hand off your bookkeeping? WSC Accounting LLC handles monthly bookkeeping for small businesses — see our plans.
Frequently Asked Questions
Can a sole proprietor use accrual accounting?
Yes. Sole proprietors can use either method. Cash basis is more common because of its simplicity, but accrual is allowed and sometimes preferable if the business has significant receivables or inventory.
Does QuickBooks support both cash and accrual accounting?
Yes. QuickBooks Online lets you toggle between cash and accrual basis on most financial reports, which is useful for seeing both views without maintaining two separate sets of books.
What happens if I have been using the wrong accounting method?
You will need to formally change methods with IRS approval via Form 3115. Your accountant can help you assess the tax impact of the change and file the appropriate paperwork.
Is accrual accounting required for GAAP compliance?
Yes. Generally Accepted Accounting Principles require accrual accounting. If you are seeking outside investment or planning for an eventual sale, GAAP-compliant financials are often expected.
Which method makes tax planning easier?
Cash basis generally offers more flexibility for tax planning because you have more control over the timing of income and expenses. However, the best strategy depends on your specific situation.
What is modified cash basis accounting?
Modified cash basis is a hybrid that uses cash basis for most transactions but applies accrual for long-term assets and liabilities. It is not formally recognized by GAAP but is used by some businesses as a practical middle ground.
Not sure which accounting method is right for your business? Talk to WSC Accounting — we help small business owners across the U.S. choose the right accounting approach, set up their books correctly, and keep them that way.
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Frequently Asked Questions
What is the difference between cash basis and accrual accounting?
Cash basis accounting records income when payment is received and expenses when they are paid. Accrual accounting records income when it is earned and expenses when incurred, regardless of when cash changes hands. Accrual provides a more accurate picture of your financial position over time.
Which accounting method is better for a small business?
It depends on your size and complexity. Cash basis is simpler and gives a clear view of actual cash — ideal for sole proprietors and small service businesses. Accrual is required for larger businesses and provides a more complete financial picture for growth planning.
Can a small business switch from cash basis to accrual accounting?
Yes, but it requires IRS approval (Form 3115) and can be complex to execute. You will need to adjust your books to account for outstanding receivables and payables. Working with an accountant before making this switch is strongly recommended.
Does the IRS require a specific accounting method?
The IRS allows most small businesses with average annual gross receipts under $30 million to use cash basis. However, C corporations and businesses with inventory are often required to use accrual. Your accountant can confirm which method applies to your situation.
How does my accounting method affect my taxes?
With cash basis, income is taxed in the year it is received, giving you some flexibility in timing. With accrual, you may owe taxes on income not yet collected. Your choice of method can meaningfully affect your tax liability, especially at year-end.
Not sure which accounting method is right for your business? WSC Accounting LLC can help you evaluate your options and set up your books correctly from the start.
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