Cash vs. Accrual Accounting: What Small Business Owners Need to Know
As a small business owner, it’s easy to focus on sales, customer service, and daily operations. But one foundational decision can shape how you understand your business’s finances: your accounting method. The two most common approaches — cash accounting and accrual accounting — each have their strengths, and in some cases, the IRS may even require you to use one over the other.
Let’s break down the differences and help you understand which method makes the most sense for your business.
What Is Cash Accounting?
Cash accounting is the simpler of the two methods. You record income only when you receive payment and expenses only when you actually pay them.
Example: You invoice a client in March, but they pay in April. Under cash accounting, you record the income in April, when the money hits your account.
Why Small Business Owners Like It:
Easy to implement and maintain
Shows your actual cash on hand
Great for businesses with few or no receivables
What Is Accrual Accounting?
Accrual accounting tracks income and expenses when they are earned or incurred, not necessarily when the money changes hands.
Example: You invoice that same client in March, and even if they pay in April, you still record the income in March, because that’s when the work was done.
Why It’s More Accurate (and Sometimes Required):
Gives a clearer picture of your profitability month by month
Matches income to the expenses that helped generate it
Better for long-term planning, budgeting, and loan applications
When Is Accrual Accounting Required?
For some small businesses, the choice is made for you. According to the IRS, you must use accrual accounting if:
Your business makes over $27 million in average annual gross receipts (for the previous 3 tax years).
You maintain inventory for resale — for example, if you're a retail store or manufacturer.
You’re a C Corporation or a partnership with a C Corporation as a partner (subject to certain thresholds).
Even if your business doesn’t fall into one of these categories, banks and investors may still require accrual-based financials to approve loans or funding.
Why the Difference Matters
Let’s say you had a great month in sales but haven’t collected the cash yet. With cash accounting, your books show a flat month. With accrual accounting, you capture the revenue when it’s earned — giving you a more realistic snapshot of business performance.
This can significantly impact:
Cash flow planning
Loan applications
Tax strategy
Understanding whether your business is truly profitable
Which Method Should You Choose?
Here’s a quick guide:
Situation Recommended Method
You're a sole proprietor or freelancer with no inventory Cash
You run a service-based business with simple transactions Cash
You carry inventory or offer payment terms to customers Accrual
You're growing quickly or seeking investment Accrual
You want accurate monthly reports for forecasting Accrual
Note: If you start with cash accounting and later switch to accrual (or vice versa), you must get IRS approval by filing Form 3115. It’s best to do this with the help of a tax professional.
Final Thoughts
As a small business owner, it’s tempting to choose the easiest path when it comes to bookkeeping. But understanding when accrual accounting is required, and when it may give you better insight into your business, is key to making smarter decisions.
If you’re unsure which method is right for you, lets talk! A short conversation can help you avoid costly mistakes and set your business up for sustainable growth.