Cash Basis Accounting vs. Accrual Basis Accounting – What’s the Difference?

Recording your business’s revenue and expenses may seem like a straightforward task. When your business sells a product or service, you record revenue. When your business buys something, you log it as an expense. In theory, this should be an easy task to accomplish. In reality, however, recording revenue and expenses for your business can be complex, and selecting the most suitable business accounting method can be challenging.

This article explains the two different methods you can use to record transactions, along with the advantages and disadvantages of each:

  • The cash method

  • The accrual method 

So let’s dive in by first looking at the two methods you can use to record a financial transaction. This will help you determine which strategy is the best choice for your business.

Cash Basis Accounting vs. Accrual Basis Accounting Key Takeaways: 

  • Gain a foundational understanding of cash basis and accrual basis accounting

  • Determine which method is optimal to record income for your operations 

  • Learn how unearned revenue applies to both methods 

  • Gain insights into switching from one accounting method to another 

Method #1: Cash Basis Accounting

Cash basis accounting uses the cash itself to determine when a transaction is recorded:

  • Revenue transactions are recorded on the date you receive cash from a customer as payment for a product or service.

  • Expense transactions are recorded on the date you spend the cash when making a purchase.

Cash Basis Accounting Examples

  • Example #1: A customer purchases an item from you for $500 on November 15. On the date of the sale, you provide the customer with an invoice for $500, but you don’t receive payment until December 15. You’ll record revenue when you receive the $500 in cash on December 15.

  • Example #2: You hire a technician for $750 to repair several of your business’s computers. The technician makes the repairs on December 20 and gives you an invoice. You pay the $750 invoice on January 20. You’ll record the expense when you pay the $750.

Method #2: Accrual Basis Accounting

Accrual basis accounting uses the actual act of exchanging a product or a service to determine when a transaction is recorded:

  • Revenue transactions are recorded on the date that a customer becomes legally obligated to pay you for providing a product or a service. This may or may not be the same time when cash changes hands.

  • Expense transactions are recorded on the date that you become legally obligated to pay for a product or service you receive. Similar to revenue transactions, this may or may not be the same time when cash changes hands.

Accrual Basis Accounting Examples

  • Example #1: A customer purchases an item from you for $500 on November 15. On the date of the sale, you provide the customer with an invoice for $500, but you don’t receive payment until December 15. You’ll record the $500 of revenue on November 15, the date of the sale.

  • Example #2: You hire a technician for $750 to repair several of your business’s computers. The technician makes the repairs on December 20 and gives you an invoice. You pay the $750 invoice on January 20. You’ll record the expense of $750 when the technician performs the repairs on December 20.

Cash vs. Accrual Accounting

Cash Basis Accrual 
Revenue Recognition  Revenue is recognized when it is received.  Revenue is recognized when it is earned. 
Accounts Maintained 

  • Cash accounts

  • Revenue and expense accounts

  • Optional accounts (includes accounts payable and receivable, but aren't mandatory) 

  • Balance sheet accounts

  • Accounts receivable 

  • Accounts payable

  • Accrued liabilities 

  • Unearned revenue 

  • Revenue and expense accounts 

  • Balance sheet accounts

  • Income statement accounts 
Complexity  Low complexity. Transactions are recorded when cash is paid or received.  High complexity. Transactions are recorded regardless of cash flow when revenue is earned or expense are incurred. 
Accuracy  Less accurate view for businesses seeking to understand precise long-term financial performance. More accurate picture for businesses interested in understanding precise long-term financial performance.
Suitability  Best for small businesses, freelancers, independent contractors, and other entities with simple cash-based operations and no Generally Accepted Accounting Principles (GAAP) requirements.  Best for larger businesses and other entities with complex translations that must adhere to GAAP rules. 
Taxation  Business revenue is taxed in the period where cash is received and expenses are deducted upon cash payment.  Business revenue is taxed when earned and expenses are deducted when incurred, and isn't determined by when cash is paid or received. 
Strategic Analysis  Cash basis accounting is best for short-term strategies where cash on hand is critical, and is less effective for long-term ambitions.  Accrual accounting is best suited for businesses with long-term growth ambitions, but it is more demanding than cash basis accounting.

Which Method is Better?

From aiding forecasting to helping with decision-making, there are pros and cons to using each method. Small business owners typically use cash basis accounting because it’s simpler and less expensive. Business owners who run larger companies use accrual accounting because it provides a more accurate financial picture for lenders and investors regarding a company’s financial health.

There are scenarios where a business may outgrow the cash accounting method and need to switch to accrual accounting, including key IRS compliance triggers and GAAP requirements once $25 million in gross receipts is exceeded.

Transitioning to a different accounting method is easy with 1-800Accountant's affordable, full-service bookkeeping and tax advisory solutions.  

Cash Basis Accounting

Advantages Disadvantages
Bookkeeping is simple: revenue is recorded when cash is received, and expenses are recorded when cash is spent. True profitability is difficult to measure. A customer who buys something from you for $100 every month pays all cash upfront in January for an entire year. January revenue will show $1,200. Every other month will show $0 of revenue.
Easy to measure cash - You always know how much cash you have available to spend, assuming you consistently reconcile all bank accounts.
Paying income taxes - Revenue is taxable only when cash is received; expenses are deductible when cash is spent.

Accrual Basis Accounting

Advantages Disadvantages
Provides an accurate financial snapshot - A customer who buys something from you for $100 every month pays all cash upfront in January for an entire year. Every month of the year will show revenue of $100. Bookkeeping is more complicated. Revenue is recorded when it is earned; expenses are recorded when an obligation to pay is created. However, sometimes it isn’t clear when revenue is earned or expenses are incurred.
GAAP compliant - The accrual method adheres to a set of rules known as GAAP. These rules are required to be followed by certain companies (usually larger companies) when preparing financial statements that people outside the company will use.

Bookkeeping requires more work - Our customer who paid $1,200 upfront requires entering 12 different transactions, one per month. Each transaction also has a corresponding document that must be stored in a secure location.
More difficult to measure cash - The accrual method does not provide an accurate snapshot of available cash; additional calculations are required to create a cash flow report.
Paying taxes - Revenue is taxed when earned, even if cash hasn’t been received.

Which Method is Right For Your Business?

If you’re a home-based business with no employees, a cash basis accounting system is the best approach. If you’re a large, multinational business, you’ll be required to use accrual basis accounting.

What if your business falls within these two extremes?

Here are some factors to consider when deciding whether cash basis accounting or accrual basis accounting is the right method for your business.

  • Business is simple. Cash basis accounting is most suitable for fairly straightforward businesses, such as those that receive cash as soon as services are rendered or a product is sold.

  • Predictable cash flow. If customer payments typically follow a consistent pattern tax year after tax year, cash basis accounting may be a suitable choice for your business. You intuitively know when cash is coming into your company and don’t have to rely consistently on financial statements to show you’re making a profit.

  • Inventory. If your business has inventory, your financial statements will be more accurate if you use the accrual basis accounting method to expense your inventory when it is sold, rather than when you purchase it.

  • You’re required to use accrual basis accounting. If your business meets specific requirements, you must use the accrual method of accounting. For example, the IRS requires you to use the accrual method when your business exceeds $25 million in gross revenue.

Frequently Asked Questions

Is cash or accrual accounting best for taxes?

Tax planning and financial management for small businesses can get complicated very quickly, which is why many entrepreneurs turn to 1-800Accountant's tax advisory service for guidance. Ideally, your business would use the cash method for as long as possible because it offers more flexibility. For example, you could prepay 2025 insurance premiums in December 2024 and deduct them on your 2024 tax return. Using the accrual method, you can only deduct 2025 expenses on your 2025 tax return.

The same theory applies to receiving payments from customers. If you make a sale in December 2024 but receive payment from the customer in January 2025, you would include that income on your 2025 tax return using the cash method. If you use the accrual method, you would be required to include this revenue on your 2024 tax return.

Which type of accounting is easier?

Cash basis accounting is generally considered the simpler method of accounting. Whether you use a spreadsheet or accounting software, it's a reasonably straightforward process adopted by small businesses, freelancers, and other entities that require less demanding tracking while being exempt from any GAAP obligations. Accrual accounting is generally considered more complex and resource-intensive than the cash basis method.  

Is it difficult to switch from cash to accrual accounting, or vice versa?

Switching from one method to the other may not be difficult, but it is certainly cumbersome. This is a decision that should be discussed not only internally within your organization with all relevant stakeholders but also with your outside team of trusted advisors who may be tasked with leading the transition. 

Is cash basis accounting GAAP compliant?

Only the accrual method can be used when preparing GAAP-compliant financial statements. Remember the purpose of GAAP - to provide a clear, complete picture, and comparable information on an organization’s financial statements.

What is the matching principle, and how does it apply to these methods?

This principle requires expenses to be recorded in the same period as the revenues they helped create, which yields more accurate financial statements. Due to the nature of cash basis accounting, the matching principle isn't typically applied. However, due to the nature of accrual accounting, this principle is fully applied. 

What are deferrals?

Revenue or expenses recognized in financial statements at a later date than when the cash is paid or received is known as a deferral. While deferrals are significant when using the accrual method, they are not applicable in cash basis accounting. 

How are amortization and depreciation used in accrual accounting?

When your business allocates the cost of assets over their useful lives, ensuring expenses are matched with revenue generated as determined by the matching principle, those methods are known as amortization and depreciation. Amortization allocates the cost of intangible assets and specific financial assets over their useful lives, while depreciation spreads the cost of tangible fixed assets over their useful lives.   

What is unearned revenue, and how does it apply to these methods?

Unearned revenue is money received for goods or services that have not yet been fulfilled and is considered a liability. Unearned revenue is typically not tracked as a liability if you're using the cash basis method, due to a focus on cash flow. However, it is tracked via the accrual method as a liability and is considered a key concept for this method.  

Work with accounting experts

Deciding which accounting method is right for your business depends on what you want to get from your accounting system. Is a simple bookkeeping process more important than truly accurate financial statements? Are you willing to invest the time and resources necessary to properly maintain an accrual basis accounting system?

Working with expert bookkeepers, such as those who power 1-800Accountant's full-service bookkeeping solution, can help transition your business from a cash to an accrual basis seamlessly, ensuring compliance and peace of mind. 1-800Accountant’s CPAs and tax professionals routinely advises businesses, via year-round tax advisory services, on the right accounting method to help them make informed decisions.

Don't wait - partner with 1-800Accountant, America's leading virtual accounting firm, today to help assess which accounting method is the best fit for your business. Schedule a quick consultation – usually 30 minutes or less — to learn more and get started.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.