When your business is just getting off the ground, you might opt for the cash basis accounting method—meaning you track your finances based on when you receive payments from customers and make payments to others. But as your business grows and becomes more complex—say you decide to offer 30-day payment terms as your customer base expands—cash accounting may no longer suffice. In that case, you need to move up to a more comprehensive accounting method called accrual basis.
Here is what you need to know about the difference between cash basis and accrual basis accounting, and how understanding each can help you decide which method suits your business.
What is cash basis accounting?
Cash basis accounting, as the name implies, records transactions only when a business receives or makes cash or comparable payments. It’s also sometimes called the cash receipts and disbursements method. It focuses on cash flow and cash balances, and doesn’t account for payments yet to be made or received.
What is accrual basis accounting?
The accrual accounting method records income when it’s earned and expenses when they’re incurred, regardless of when payments are made. Accrual accounting is guided by a concept called the matching principle: Income produced from sale of goods or services should be matched in the same time period with expenses incurred in production of those goods or delivery of services. The purpose of matching is to help a business align income and expenses across time, helping owners or managers see if it’s operating profitably.
A key feature of accrual accounting is the use of accounts receivable and accounts payable, reflecting money owed to and by a business, respectively. These accounts allow businesses to factor in unpaid invoices and bills into their financial picture at any given moment. Accrual basis requires everything to be accounted for in a timely manner, rather than waiting for cash to change hands before recognizing income and expenses.
Example of cash basis vs. accrual basis
Imagine a maker of custom-printed tote bags produces a $2,000 order in June for a charity golf event in July. The business delivers the bags on July 10 and gets paid on delivery. It incurred $1,000 in expenses in June to make the bags, which it paid to its suppliers on net-30 terms, on July 20.
Using cash basis accounting, the business records the expenses and income associated with the order in July, when the cash flowed in and out—instead of in June, when the work was done. Accrual accounting would require the business to recognize income and expenses for June, to show that the business made a $1,000 profit on the work.
When to use cash basis accounting
Businesses that use cash basis accounting typically are very small, such as sole proprietors, freelancers, and small retailers, with simple operations and bookkeeping focused on tracking cash balances in their checking accounts. They often accept only cash, check, or ACH payment, and they don’t extend credit or carry any inventory. For newer or very small businesses, staying afloat is their main concern, and knowing their cash balance can determine when they can pay their bills.
Benefits of cash basis accounting
Benefits of using the cash basis include:
Simplicity
Cash accounting is easy to get started and to maintain because businesses that use it usually have few things to track. There’s less to learn and understand with the cash method, and a business can often just examine its bank account to know its cash flow.
Little cost
For the simplest businesses, cash accounting can be a do-it-yourself job, involving a spreadsheet or a manual ledger and squaring it with the business bank account. There may be no need to buy accounting software or hire a bookkeeper, especially if the business intends to remain small.
Cash flow accuracy
Cash-based businesses or those with simple financial structures benefit from knowing the amount of available cash, rather than having to square an income statement with money yet to be collected or paid.
Tax timing
Businesses using the cash basis for their taxes pay taxes only on profits that have been recognized—meaning they have actually received payment for the work. They can manage taxable income for a particular period based on actual income recognition and expense recognition. For example, if a business completes an order for tote bags in December 2025 but isn’t paid for them until January 2026, it would pay taxes on that income for tax year 2026.
Drawbacks of cash basis accounting
At the same time, using a cash basis can have some drawbacks:
Incomplete financial picture
Cash basis accounting doesn’t account for money you owe, or money owed to you. This may give a misleading financial picture (the business could be weaker or stronger than you think). Because it monitors cash flow rather than accrued income and accrued expenses, without a record of accounts receivable or accounts payable, cash accounting presents a one-dimensional picture of the business’s financial condition.
Not GAAP-approved
Generally accepted accounting principles (GAAP) require use of the accrual basis for bigger businesses and for those companies with public shareholders. GAAP also complies with auditors and regulatory authorities such as the Securities and Exchange Commission, which views accrual accounting as presenting a clearer and more consistent picture of the business’s condition than cash accounting.
When to use accrual basis accounting
Larger businesses, such as corporations with complex operations, as well as businesses offering or using credit and carrying inventories, must use accrual accounting. Also, businesses seeking outside financing must use accrual accounting because lenders and equity investors want accrual-based financial statements for review before committing their capital.
Benefits of accrual basis accounting
Benefits of using accrual basis include:
Transparency
Accrual accounting makes a business’s financial position clearer by showing anticipated cash flows—accounts receivable and payable—as well as current flows. By matching revenue with associated expenses, accrual accounting gives managers insight into the true costs and profitability of a business’s operations.
Conforms to GAAP
Companies in the US with publicly traded shares must abide by GAAP standards, which include accrual basis accounting. Businesses using the cash basis might consider switching to accrual soon if they expect to reach a size at which accrual becomes mandatory.
Clarity for stakeholders
Investors, creditors, and other stakeholders such as suppliers rely on accurate and thorough financial statements to make informed decisions. Accrual accounting shows them a company’s operational effectiveness and financial stability more clearly than cash accounting.
Drawbacks of accrual basis accounting
Some challenges in using the accrual basis include:
Complexity
Accrual basis accounting involves more detailed recordkeeping, as well as rules and procedures for recognition of income and expenses at the appropriate times. Businesses that use the accrual method must regularly reconcile their accounts receivable, accounts payable, and accrued expenses. Reconciliations often are time-consuming, requiring close attention to detail to find and correct any discrepancies. Further, tax rules and forms can be more complicated for accrual-basis companies.
Cost
Implementing and maintaining an accrual accounting system can incur substantial costs, including for hiring bookkeepers and accountants familiar with accrual accounting rules and standards.
Cash flow discrepancy
Although accrual-based accounting may provide a fuller perspective on the business’s growth and profitability, it doesn’t provide a direct picture of cash flow. This is important for businesses that sell on credit. They must manage their cash flows to ensure they have sufficient liquidity for day-to-day operations.
Taxes
Because of when revenue and expenses are recorded, a business’s tax liability may be higher at certain times under the accrual basis. For example, a business that delivers $10 million of goods to a customer on December 15, may not receive payment until January 15. Using the accrual method, it must record the $10 million as income for the year ending in December, increasing its taxable income base for the year.
Compliance
Accrual accounting’s complexity increases the risk of errors in financial statements, which can lead to possible non-compliance with accounting rules. This is because accrual accounting can sometimes be based on estimates and judgments, such as allowances for doubtful accounts and how to depreciate asset values. These can introduce errors and biases into financial statements.
Cash basis vs. accrual basis FAQ
Which is better—cash basis or accrual basis?
The choice of which accounting basis is preferable depends on the size and complexity of the business. Very small businesses with simple operations likely will find cash accounting sufficient. Growing businesses and companies with complex operations typically use accrual accounting, and in many cases financial and accounting regulators and tax authorities require use of accrual basis.
Who uses cash basis accounting?
Sole proprietors, mom-and-pop businesses, such as small retailers, and freelance providers of services, such as designers, writers, and plumbers, often use cash accounting because their businesses are simple, with relatively few transactions in a given period.
What are the disadvantages of cash basis accounting?
The main disadvantages of cash basis accounting are that it ignores pending payments from customers and to suppliers, because it lacks accounts receivable and payable, which accrual accounting uses to track those payments. Because cash basis doesn’t account for pending payments, the cash method provides an incomplete and potentially misleading picture of a business’s financial condition.
