Accrual vs. cash accounting methods: What’s the difference?

The main difference between the accrual method and the cash—or cash-basis—method of accounting is when income and expenses are recorded and reported. Both types of accounting help businesses track finances, but they recognize transactions at different points in time. While the cash method can be a simpler way to track income and expenses, the accrual method can provide a more comprehensive picture of long-term profitability.

If your business earns less than $30 million in average annual revenue over three years and isn’t publicly traded, you can generally choose either accrual or cash accounting—but the IRS typically requires businesses to use the same method consistently throughout the year. Learn more about these two accounting approaches to decide which one is right for your business.

What you’ll learn:

• Accrual and cash-basis accounting are two accounting methods businesses can use to record and report income and expenses.

• Accrual accounting records income when it’s earned and expenses when they’re billed, whereas cash-basis accounting records income when it’s received and expenses when they’re paid.

• Accrual accounting can be a more complex system because it tracks accounts receivable and payable, but it can be used by all businesses—including those that are larger and publicly traded. 

• Cash-basis accounting tends to be a simpler way to record income and expenses, but it doesn’t represent the full financial picture and can’t be used by all companies.

Accrual accounting is an approach that records your business’s revenue as it’s earned and company expenses as they’re billed—no matter when funds are actually received. With this method, revenue is recorded once it’s earned and the business delivers the agreed-upon services or products to the customer. By the same token, expenses are recorded when they’re incurred rather than when they’re paid. 

Accounts payable (AP) and accounts receivable (AR) are two main components of accrual accounting because they can help businesses track when they owe money to suppliers and, conversely, when customers owe money to the business.

Smaller businesses and larger corporations alike can use accrual accounting. But once a company makes over $30 million in average annual revenue over a three-year period or is publicly traded, the accrual method is generally required, in accordance with U.S. Generally Accepted Accounting Principles (GAAP) standards and certain IRS rules.

Say you own a SaaS company and bill a client $5,000 on April 1 for cybersecurity monitoring and receive payment on May 13. You would record this $5,000 as income earned in April, even if the funds weren’t received until the middle of May. 

This process also looks the same for your expenses. Say you purchased $13,000 worth of new computers for your employees from a vendor in November but didn’t remit payment until December. You would still record this as an expense from November because that’s when you actually received the bill.

Cash-basis accounting is a method where revenue is recorded when it’s received and expenses when they’re paid. This is a simpler approach to accounting because it doesn’t require tracking AR and AP. Because there are no timing differences between revenue earned and funds received, cash-basis accounting can provide clearer insight into a business’s cash flow. Startup companies with 10 employees or fewer might use cash-basis accounting when looking for a short-term snapshot of profitability.

Take the same example of an IT company that bills $5,000 for cybersecurity monitoring on April 1 but actually receives payment on May 13. With cash-basis accounting, you would record this invoice as income received in May—even though it was sent in April.

By the same measure, if you purchased $13,000 worth of new computers in November but didn’t pay the vendor until December, you would record this as a December expense based on the date the bill was paid, not received.

The main differences between accrual and cash accounting come down to when income and expenses are recorded, the complexity of each method, whether they comply with GAAP guidelines, their tax implications and the types of businesses that can use them. 

Take a closer look at how they compare.

Accrual accounting can provide a more accurate view of a business’s long-term financial performance, though it often requires a more time-consuming process and less visibility into cash flow.

The accrual method of accounting is advantageous because it provides a more comprehensive overview of profitability and can be used by businesses of all sizes.

• Promotes greater accuracy: Because income and expenses are recorded when they occur and accounts receivable and accounts payable are tracked, accrual accounting can provide a more complete picture of a business’s financial health.

• Preferred method for long-term tracking: Accrual accounting can be a better way to forecast because it accounts for committed revenue and expenses.

• Suitable for all businesses: Small and large companies alike can use the accrual method because it’s GAAP-compliant. And growing businesses might choose this method to avoid transitioning from cash-basis to accrual accounting once the company hits a revenue threshold or becomes publicly traded.

The accrual method of accounting can have some challenges because it can be a more complex process and it doesn’t provide as clear a picture of cash flow.

• Increased complexity: Businesses using this system typically have to track revenue and expenses before payment is received or made, as well as AR and AP. 

• More resources required: Because accrual accounting generally requires a double-entry bookkeeping method, more advanced accounting software could be necessary.

• Incomplete visibility of cash flow: Accrual accounting might record a certain amount of sales revenue before payment is received. This means those funds may not be liquid or available to the business.

Cash-basis accounting can be a simpler accounting system, but it doesn’t offer as much insight into a business’s overall profitability and not all companies can use this method. 

Cash-basis accounting can be advantageous for businesses looking for a simpler way to understand short-term profitability while maintaining direct visibility into the company’s cash flow. 

• Simpler system: Cash-basis accounting is a simple way to track how income and expenses move in and out of your company—without the need to record AR or AP. 

• Less administrative effort required: Compared to accrual accounting, cash-basis accounting might not need sophisticated tools or additional resources to maintain accurate financial records.

• Ease of cash flow monitoring: Cash-basis accounting considers current, rather than anticipated, transactions. This means monitoring cash flow can be easier with this accounting system because it can provide a clearer picture of how much cash is available to your business.

Cash-basis accounting can have some drawbacks because regulatory limitations prevent some businesses from using it, and it may not provide as accurate a picture of a business’s overall financial health.

• Can show inconsistent profitability: Using this method might inaccurately show the company as losing money or generating profits from month to month because expenses and revenue could be mismatched. 

• Doesn’t meet GAAP regulations: Not all businesses—particularly larger companies or those that are publicly traded—can use cash-basis accounting because it doesn’t comply with GAAP standards.

• Can limit long-term insights: When using cash-basis accounting, accounts receivable and accounts payable aren’t considered. This can make it difficult for businesses to understand the full financial picture and predict potential shortfalls or profits.

When choosing between accrual and cash basis, the best accounting method for your company comes down to the size of your organization and the financial insights you’re trying to gain.

• You might choose accrual accounting if you have a large or publicly traded company, if you’re looking for long-term insights into the business’s overall profitability, and if you have systems in place to track AR and AP.

• You might choose cash-basis accounting if you have a smaller company, if you’re trying to get a clearer picture to manage cash flow, to understand short-term financials, and if you’re looking for a simpler method that requires fewer resources and tools.

Businesses that earn under $30 million in average annual revenue over a three-year period and aren’t publicly traded can generally choose either the accrual or cash-basis accounting method. Cash-basis accounting may be a good fit for businesses looking for a simpler way to manage short-term finances and cash flow. Businesses that need more comprehensive, long-term financial insights may benefit more from accrual accounting.

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