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

Recording your business’s revenue and expenses is easy, right? When you sell something, you record revenue. When you buy something, you log it as an expense. In theory, this should be easy to do. In reality, though, things can get extremely nuanced.

In this article, we’ll explain the two different ways you can record a transaction - using either the cash method or the accrual method - along with the advantages and disadvantages of each that can help you decide which strategy may be the right choice for your business.

So let’s dive in by first looking at the two methods you can use to record a transaction: cash basis accounting and accrual basis accounting.

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 buys something from you for $500 on November 15th. On the date of the sale, you give the customer an invoice for $500 but don’t get paid until December 15th. You’ll record revenue when you receive the $500 in cash on December 15th.

    Example #2: You hire a technician for $750 to repair several of your business’s computers. The technician makes the repairs on December 20th and gives you an invoice. You pay the $750 invoice on January 20th. You’ll record the expense when you pay the $750 on January 15th.

    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. Just like with revenue transactions, this may or may not be the same time when cash changes hands.

    • Accrual Basis Accounting Examples

    Example #1: A customer buys something from you for $500 on November 15th. On the date of the sale, you give the customer an invoice for $500 but don’t get paid until December 15th. You’ll record the $500 of revenue on November 15th, 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 20th and gives you an invoice. You pay the $750 invoice on January 20th. You’ll record the expense of $750 when the technician performs the repairs on December 20th.

    Which Method is Better?

    There are pros and cons to using each method. Smaller businesses typically use cash basis accounting because it’s simple and cheaper. Larger companies use accrual basis accounting because it provides a more accurate financial picture for lenders and investors about the company’s health.

    Here’s a summary of each method’s advantages and disadvantages.

    Cash Basis Accounting

    Advantages Disadvantages
    Bookkeeping is simple - Revenue is recorded when cash is received; expenses are recorded when cash is spent. True profitability is difficult to measure - A customer you sell something to for $100 every month pays all cash up front 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 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 you sell something to for $100 every month pays all cash up front 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; sometimes, it isn’t clear when revenue is earned or expenses are incurred.
    GAAP compliant - The accrual method conforms to a set of rules called Generally Accepted Accounting Principles, or GAAP. These rules are required to be followed by certain companies (usually larger companies) when preparing financial statements that people outside of 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 somewhere.
    More difficult to measure cash - The accrual method does not provide an accurate snapshot of available cash; additional calculations must be performed 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, cash basis accounting is definitely the way to go. 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 makes the most sense if your business is pretty straightforward, such as receiving cash as soon as services are rendered or a product is sold.
  • Predictable cash flow. If customer payments usually follow the same pattern year after year, cash flow accounting may be a good 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 using accrual basis accounting to expense your inventory when it gets sold rather than when you purchase it.
  • You’re required to use accrual basis accounting. If your business meets certain requirements, you must use the accrual method. 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 for small businesses can get complicated very quickly. Ideally, your business would use the cash method for as long as possible because it offers more flexibility. For example, you could prepay 2024 insurance premiums in December 2023 and deduct it on your 2023 tax return. Using the accrual method, you can only deduct 2024 expenses on your 2024 tax return.

    The same theory applies to receiving payments from customers. If you make a sale in December 2023 but receive payment from the customer in January 2024, you would include that income on your 2024 tax return using the cash method. If you use the accrual method, you would be required to include this revenue on your 2023 tax return.

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

    Difficult may not be the correct word, but switching from one method to the other 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.

    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 clear, consistent, and comparable information on an organization’s financial statements.

    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 money to properly maintain an accrual basis accounting system?

    Partner with a 1-800Accountant small business accounting expert to help assess which accounting method is the best fit for your business.

    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.