What's the Difference Between Cash and Accrual Accounting?

This is one of the most fundamental — and most misunderstood — concepts in small business finance, and choosing the right method affects how your business looks on paper every single month.

Cash basis accounting records income when you actually receive the money, and expenses when you actually pay them. It's simple and intuitive — your books closely match your bank account. Most very small businesses and sole proprietors start here because it's easy to understand and manage.

Accrual basis accounting records income when it's earned (e.g., when you invoice a client) and expenses when they're incurred (e.g., when you receive a bill) — regardless of when the cash actually moves. This method gives a more complete picture of your business's financial position at any given moment, because it accounts for money owed to you and money you owe, not just cash currently in hand.

A simple example: say you complete a $5,000 project in December but the client doesn't pay until February.

• Under cash basis, that $5,000 shows up as income in February.

• Under accrual basis, it shows up as income in December — when the work was actually done.

Which one is right for your business?

• Cash basis tends to work well for simpler, smaller businesses without significant inventory or large amounts of unpaid invoices/bills at any given time

• Accrual basis is often required (or strongly recommended) for larger businesses, those with inventory, or businesses seeking loans or investment, since lenders and investors typically want the fuller picture accrual accounting provides

One important note: the IRS has specific rules about which businesses are required to use accrual accounting for tax purposes, generally based on revenue thresholds and business type. This is a good conversation to have with your bookkeeper or accountant rather than deciding alone — getting it wrong can mean redoing a year of books later.

The bottom line: neither method is "better" in the abstract — the right choice depends on your business's size, complexity, and goals. What matters most is choosing intentionally, rather than defaulting into one without understanding the tradeoff.