The core difference in one example
Under cash, a job done in March and paid in April is April income. Under accrual, it is March income.
Illustrative example. A contractor finishes a $10,000 job on March 20 and invoices the customer. The customer pays on April 18. The contractor buys $4,000 of materials on March 5 on credit and pays the supplier April 10.
- Cash basis: March shows no revenue and no materials expense. April shows $10,000 revenue and $4,000 expense.
- Accrual basis: March shows $10,000 revenue and $4,000 expense, with an accounts receivable and an accounts payable on the balance sheet.
Total profit is the same over time. The timing changes. Accrual matches the effort and the reward in the same period, so March correctly shows a $6,000 profit.
How cash basis works and who uses it
Cash basis tracks deposits and payments. It suits businesses with simple operations, few credit sales and no major inventory.
You count a sale when the customer pays, and an expense when you pay it. Your books look much like your bank statements, which makes them easy to keep. Many sole proprietors, freelancers and small service businesses use it.
Strengths:
- Simple to understand and maintain.
- Reports show actual cash received, which helps with short-term planning.
- Taxes are due only on money you have received, in general.
Weaknesses: it can make a month look better or worse than the work you did, because payments arrive late or in clumps. It does not show what customers owe you or what you owe suppliers.
How accrual works and who uses it
Accrual records revenue when earned and expenses when incurred. It suits businesses that sell on credit, hold inventory, have employees with accrued liabilities or seek outside financing.
Accrual accounting uses accounts receivable, accounts payable, accrued expenses and deferred revenue. These show what is owed to you and by you. Reports match revenues with the costs that produced them, giving a clearer picture of performance each month.
Strengths: better profit measurement, a complete balance sheet, and statements that lenders and investors prefer. Weaknesses: more complex, usually requires accounting software, and profit can look healthy while cash is tight because customers have not paid.
Accrual is the standard under generally accepted accounting principles (GAAP). Larger businesses and many lenders expect it. See accounting for small business for more context.
Side-by-side comparison
Compare the methods on timing, complexity, accuracy, taxes and what they show about cash.
| Feature | Cash basis | Accrual basis |
|---|---|---|
| Revenue recorded | When payment received | When earned or invoiced |
| Expenses recorded | When paid | When incurred |
| Complexity | Low | Higher |
| Shows receivables and payables | No | Yes |
| Matches revenue to costs | Loosely | Closely |
| Best for | Simple, small, low-inventory | Credit sales, inventory, growth, financing |
A third approach, modified cash, blends features. Ask your accountant whether it fits.
Tax rules and switching methods
The IRS limits who may use cash basis, and a change in method generally requires proper filing. Talk to a tax professional before switching.
Many small businesses may use the cash method for taxes. Businesses with inventory, or those above certain gross receipts thresholds, may be required to use accrual or a hybrid approach. Thresholds change, so check the current IRS rules with your accountant.
Once you pick a method for tax reporting, changing it usually requires IRS approval or specific procedures. Do not switch just because a month looks bad. Your books for management and your tax method can sometimes differ, but your accountant should handle the reconciliation.
See business tax return forms for how the method flows through to your return.
Cash flow still matters on accrual books
Accrual profit can hide cash shortages. Track receivable aging and a cash forecast alongside your accrual reports.
If you invoice on 45-day terms, accrual shows revenue immediately but cash arrives later. Meanwhile, rent and payroll must be paid now. Review your accounts receivable aging every week, and forecast cash by week.
Tools to watch the gap: the cash flow statement, a 13-week forecast and collection metrics like days sales outstanding. Our guide to cash flow vs. profit and cash flow forecasting cover the methods.
Faster invoicing, deposits and clear terms close the gap without any financing at all. See invoicing for beginners.
Choosing a method and how funders read your books
Choose the simplest method that gives you accurate decisions and meets tax rules. Funders will want to understand your numbers whichever you use.
A practical rule: if you have few invoices, no inventory and little credit, cash basis may be enough. If you invoice on terms, carry stock, have multiple employees or plan to seek bank financing, accrual or at least monthly accrual adjustments will serve you better.
Banks and SBA lenders often prefer accrual statements. Faster funders such as ROI Funder focus on business bank statements, revenue and time in business, and a complete file is the application plus three months of statements. We consider 500+ FICO, 6+ months in operation and $20,000+ monthly revenue.
If slow-paying customers create gaps, a business line of credit can cover timing while you collect.
Frequently asked questions
What is the main difference between cash and accrual accounting?
Timing. Cash records transactions when money changes hands. Accrual records them when they are earned or incurred.
Which accounting method is better for a small business?
Cash is simpler for small, simple businesses. Accrual is better when you sell on credit, hold inventory or need financing.
Can I switch from cash to accrual?
Yes, but a tax method change usually requires proper IRS procedures. Ask your accountant.
Do lenders prefer accrual statements?
Banks and SBA lenders often do. Faster funders mostly rely on bank statements and revenue.