Cash vs Accrual Accounting: Which Method Fits Your Business?
The cash method records money when it moves; the accrual method records it when it is earned or owed. Here is what that changes in your figures.
A designer finishes a project on 28 March, sends the invoice that afternoon and is paid on 15 April. Under the cash method, that income belongs to April, because that is when the money arrived. Under the accrual method, it belongs to March, because that is when the work was done and the right to payment existed. Everything else about the two methods follows from that single question: when does a transaction count?
The cash method in brief
Cash-basis accounting records income when payment is received and expenses when they are paid. An unpaid invoice you sent does not appear as income yet; a supplier bill sitting in your inbox does not appear as a cost until you settle it.
Its appeal is simplicity. The books follow the bank account closely, so the figures feel intuitive and there is less to track. Many sole traders and small service businesses start here.
The drawback is that the picture can swing. A month in which several clients happen to pay looks excellent; the month after, with the same amount of work done, can look poor. Large bills paid early or late distort results in the same way.
The accrual method in brief
Accrual-basis accounting records income when it is earned and expenses when they are incurred, regardless of when cash changes hands. Sending an invoice creates income and an amount owed to you, known as accounts receivable. Receiving a supplier bill creates an expense and an amount you owe, known as accounts payable.
This matches costs to the period that produced the revenue, so month-to-month comparisons are more meaningful. The trade-off is more bookkeeping, and the need to watch cash separately, because a business can look profitable on paper while its bank balance runs low.
Side by side
| Cash basis | Accrual basis | |
|---|---|---|
| Income recorded | When payment arrives | When the sale is made or work delivered |
| Expenses recorded | When you pay | When the cost is incurred or billed |
| Tracks money owed to and by you | Not in the main books | Yes, as receivables and payables |
| Effort to maintain | Lower | Higher |
| Shows true performance per period | Can be distorted by timing | Generally more accurate |
| Shows cash on hand | Closely | Needs a separate cash view |
A worked month, both ways
Take a hypothetical small business in June:
- It invoices 6,000 for work completed in June; none of it is paid yet.
- It receives 2,500 from customers for invoices sent in May.
- It receives a 1,200 supplier bill for June materials, due in July.
- It pays 800 in rent for June.
Cash basis: income 2,500, expenses 800, result 1,700.
Accrual basis: income 6,000, expenses 2,000 (1,200 + 800), result 4,000.
Neither number is wrong. The cash result says how much money moved in June; the accrual result says how much June's activity earned. The accrual figure is the better guide to whether the work is priced well, and the cash figure is the better guide to whether next week's bills can be paid. That tension is why businesses that sell on credit, such as those supplying wholesalers on long terms (a common arrangement described in our article on working with food distributors in the USA), usually need both views.
Which method tends to fit which business
The cash method often suits:
- sole traders and freelancers who are paid soon after doing the work;
- businesses with few transactions and no stock;
- owners who mainly need to know what is in the bank.
The accrual method often suits:
- businesses that invoice on credit terms or pay suppliers on terms;
- companies holding inventory;
- anyone seeking outside investment or bank finance, since lenders and investors commonly expect accrual-based statements;
- businesses that have outgrown simple records and want reliable monthly results.
Rules, tax and switching
The choice is not always free. Tax authorities in many countries limit who may use the cash method, often depending on the size of the business, its legal form or whether it holds stock, and those limits change over time. Our article on taxes for EU expats is a reminder of how much rules differ between places.
Switching methods is usually possible but rarely casual. It can require a formal application or adjustment so that no income or expense is counted twice or missed in the changeover year. Talk to an accountant before changing, and ideally before choosing in the first place.
Questions owners ask
Can I use one method for tax and another for management reports?
In some places, yes. Some businesses file on one basis and run internal reports on another, or use a hybrid that applies accrual treatment only to certain items. Whether that is allowed, and whether it is worth the extra work, is a question for your accountant.
Does accrual mean paying tax on money not yet received?
It can, because income is recognised when earned. That is one reason accrual-basis businesses keep a close eye on unpaid invoices and set money aside early.
Which method does bookkeeping software use?
Most packages can report on either basis from the same records, provided invoices and bills are entered rather than only bank transactions. Our guide to bookkeeping basics covers setting those records up.
This is general information, not tax or accounting advice. Eligibility and rules for each method depend on your jurisdiction and business, so confirm with a qualified professional.