Cash vs Accrual Accounting: Which Should Your Small Business Use?

So, your accounting software has asked whether you want “cash” or “accrual” basis, and you’ve no idea which to pick. Or your accountant mentioned it and you nodded along.

Don’t worry. It sounds technical, but it’s really one simple question: when do you record a sale or an expense? When the money moves, or when the work is done?

I’m an accountant, and in the next few minutes I’ll show you both methods with one example, explain which one you’re allowed to use, and tell you which I’d pick in your shoes.

The difference in one sentence

• Cash basis: you record income when you receive the money, and expenses when you pay them.
• Accrual basis: you record income when you earn it (usually when you invoice), and expenses when you owe them (when the bill arrives), regardless of when cash moves.

One example, both ways

Say you’re a web designer. In March you finish a $2,000 project and invoice the client, and they pay you in April.

Also in March, you get a $300 bill for software, which you pay in April.

	Cash basis	Accrual basis
March income	$0	$2,000
March expenses	$0	$300
March profit	$0	$1,700
April income	$2,000	$0
April expenses	$300	$0
April profit	$1,700	$0

Over the two months, the total is the same: $1,700 either way. What changes is which month it lands in.

On cash basis, March looks like a dead month even though you did the work. On accrual, March shows the profit you earned, and the $2,000 sits on your balance sheet as money owed to you (accounts receivable) until the client pays.

Cash basis: pros and cons

• Simple. Your books follow your bank account, so they’re easy to understand.
• Tax follows cash. You generally pay tax on money you’ve actually received.
• But it can hide problems. A month with lots of unpaid invoices looks worse than it is, and a month of unpaid bills looks better than it is.

Accrual basis: pros and cons

• A truer picture. Income and costs line up with the month the work happened.
• Better for decisions, and it’s what lenders and investors usually expect to see.
• But it takes more care: you track what you’re owed and what you owe, and profit on paper can be very different from cash in the bank.

How the choice affects your tax bill

The method you choose decides which tax year some income falls in. That matters most around year-end.

Say you invoice a client $5,000 on 20 December and they pay on 10 January:

	Cash basis	Accrual basis
Income in this tax year	$0	$5,000
Income in next tax year	$5,000	$0

On cash basis, you pay tax on that $5,000 a year later. On accrual, it counts now, even though the money isn’t in your bank yet.

Neither is “cheaper” over time. But it changes when tax is due, and your accountant will plan around it.

What accrual adds to your balance sheet

On accrual, a few accounts appear that cash-basis books barely use:

• Accounts receivable: invoices you’ve sent but haven’t been paid for.
• Accounts payable: bills you’ve received but haven’t paid.
• Prepayments: things you’ve paid for in advance, like a year of insurance, spread over the months they cover.
• Accruals: costs you’ve used but haven’t been billed for yet.

Don’t worry about the last two at first. Your accountant usually handles them at year-end.

Which method are you allowed to use?

This is where the country matters. Here’s the general picture. Check your own situation with your accountant.

United States

Many small businesses can choose either method for tax, but there are limits. Larger businesses, and some businesses with inventory, may need accrual.

Once you choose a method you use it consistently, and changing it later generally requires IRS approval (usually on Form 3115). IRS Publication 538 explains the rules.

United Kingdom

Since the 2024–25 tax year, the cash basis is the default for sole traders and partnerships under Self Assessment, and you can opt out to use accrual (traditional) accounting. Limited companies can’t use the cash basis for Corporation Tax. Separately, VAT-registered businesses below HMRC’s turnover threshold can use the VAT Cash Accounting Scheme.

Australia

For GST, businesses with an aggregated turnover under $10 million can generally choose to account for GST on a cash basis. The ATO’s website explains the conditions, and your BAS agent or accountant can confirm what applies to you.

Which should you choose?

Your situation	What I would usually suggest
Sole trader or freelancer, paid quickly, few bills	Cash basis, if you are allowed to use it
You invoice customers who pay 30+ days later	Accrual for your management reports, even if tax is on cash
You hold stock or sell products	Talk to your accountant: accrual is often required or wiser
You plan to borrow or raise money	Accrual, because that is what lenders read
Limited company in the UK	Accrual (cash basis is not available)

Here’s the bit most guides miss: you can often run your reports both ways. Many accounting tools let you switch reports like the profit and loss between cash and accrual, so you can see both pictures.

In QuickBooks Online, most reports have an accounting method option at the top. In other tools, look in the report settings. If you can’t find it, ask your accountant or the software’s help centre which basis your reports use, because it changes the numbers.

Common mistakes

Switching methods without telling anyone

Changing method changes your taxable income. Talk to your accountant first; in the US a formal change usually needs IRS approval.

Thinking cash basis means “no invoices”

You still invoice customers and track who owes you on cash basis. You just don’t count it as income until the money arrives.

Reading an accrual profit as cash in the bank

A profitable month on accrual can still leave you short of cash if customers pay late. Watch your cash flow alongside your P&L.

Frequently asked questions

Is cash or accrual better for a small business?

Cash is simpler and fine for many very small businesses. Accrual gives a truer picture once you have customers on payment terms, bills, or stock.

Does accounting software handle both?

Yes. You record transactions the same way, and the software reports on the basis you choose. Many tools let you run reports either way.

Can I change from cash to accrual later?

Yes, but do it at the start of a tax year and with your accountant, because it changes when income and expenses are counted. In the US it usually requires IRS approval.

What is modified cash basis?

It’s a hybrid: mostly cash, with some items (like equipment or loans) handled the accrual way. Some accountants use it for management reports. Ask yours if it suits you.

What to do next

Once you’ve chosen your method, the next foundation is your list of categories. Read chart of accounts for small business, or go back to the full small business bookkeeping guide.