Cash-Basis vs. Accrual-Basis Accounting: What’s the Difference? What’s Best?

Companies can choose between two primary accounting methods: cash basis and accrual basis. The adage “timing is everything” captures the biggest difference between them. Cash accounting reflects business transactions on a company’s financial statements entered when the cash flows into or out of the business. Accrual accounting recognizes revenue when it’s earned and expenses when they’re incurred, regardless of when money actually changes hands. The difference in timing ripples through the company’s income statements and balance sheet, and subsequently affects its tax liability.

Each method has advantages and disadvantages. Notably, the cash method is more straightforward. But only the accrual basis is accepted by Generally Accepted Accounting Principles (GAAP), which is a set of rules established by the Financial Accounting Standards Board (FASB). Depending on a company’s circumstances, it may be easy to choose which method is the best fit.

What Is Cash-Basis Accounting?

Cash-basis accounting makes possible the most straightforward method of bookkeeping. It records revenue when cash is received and expenses when cash is paid. For example, if a local handyman paints a customer’s living room on May 21 but receives the customer payment on June 1, the handyman records the revenue on June 1. Similarly, if the handyman paid his paint supplier for materials to do this job on May 15, he records the expense in May. There is no connection between when the work is performed and when it is recorded in the handyman’s books—only the movement of cash matters.

What Is Accrual Accounting?

Accrual accounting recognizes revenue when it is earned and expenses when they are incurred. Revenue is considered earned when the goods or services have been provided to the customer. Expenses are incurred when a company receives goods or services. Accrual accounting also aims to match the timing of expenses to the revenue that they support, within a fiscal period. As a result, it requires a more sophisticated understanding of the timing of underlying transactions than cash-basis accounting, since it’s not tied to when cash changes hands.

Using the handyman example, under accrual basis revenue would be recognized in May, since that’s when the job was completed and the revenue “earned.” When the handyman pays his May cell phone bill on June 15, accrual accounting dictates that the expense be recognized in May, since that’s the period when the service was provided. Treatment of the purchase of supplies is a little more involved. Even though the handyman preordered the supplies in April, this expense would be reflected in May in order to match the timing of when the related revenue was earned.

Key Takeaways

• A company should choose an accounting method based on how it does business and whether it needs GAAP-compliant financial reporting.
• Cash-basis accounting is easier to maintain and provides a clear view of cash position, since transactions are recorded when money changes hands.
• Accrual accounting recognizes revenue when it is earned and expenses when they are incurred, regardless of cash flow timing; it is the GAAP-compliant option.
• The chosen accounting method affects tax planning, cash flow management, accounting systems, and level of staff expertise needed.
• Accrual accounting is considered the gold standard, requiring double-entry bookkeeping and best implemented with accounting software.

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

Cash-basis accounting is the easier of the two methods because, as its name implies, all bookkeeping simply follows the cash. The company records revenue when customer payments are received. It records expenses when it makes payments to suppliers. Taxes are calculated on the resulting net income.

Under the cash basis, there is no need to account for customer sales made on credit (as accounts receivable) between the time they are invoiced and the time they pay. Similarly, no bookkeeping is required for purchases from vendors on credit (as accounts payable or accrued expenses) until the company pays for them. Cash-basis accounting is a simple way to check a company’s cash status.

Example: The following example illustrates the timing and simplicity of cash accounting for a small business. It also shows the swings in taxable income that can result from using this method.

ITCHY Inc., a fictional tree-spraying company, provides a monthly insect-prevention spraying service for its customers. A customer signs an annual contract and pays $1,200 up front on June 1, 2024. ITCHY pays its chemical supplier $50 per tank of insecticide; this customer requires one tank, which ITCHY pays for when it picks up the tank on the morning of each monthly spray. Under cash-basis accounting:

• ITCHY records all $1,200 of revenue in June.
• ITCHY records $50 in expenses each month.
• ITCHY’s income/(loss) for each of the 12 months is shown below.
• ITCHY pays income taxes on $850 of income for 2024 and shows a loss for 2025.

Accrual-basis accounting combines two important accounting principles: the matching principle and the revenue recognition principle. Under these principles, revenue is recognized when it is earned, and expenses are reflected when incurred or in the period that best matches the revenue they help create. Accrual accounting bookkeeping is uncoupled from when the money involved actually changes hands, thereby smoothing the impact of timing and yielding a more accurate overall picture of a business’s operations and its finances.

Example: Using the same fictional example presented above, the following chart shows ITCHY’s financial results using the accrual method:

• ITCHY evenly prorates the $1,200 cash as $100 of revenue for each of the obligated 12 sprays.
• ITCHY records $50 in expenses in each month.
• ITCHY’s gross income/(loss) is shown for each of the 12 months.
• ITCHY pays income taxes on $350 of income for 2024 and $250 for 2025.

Comparing the Key Differences, Advantages, and Disadvantages

The most significant difference between the cash and accrual methods relates to the timing of revenue and expenses: namely, when they’re received/paid and when they’re earned/incurred.

Many businesses prefer to use cash accounting because the financial statements closely reflect their cash position, which is especially important for small-business owners. The simplicity also makes bookkeeping easier and less expensive. And under cash-basis accounting, a business never has to pay taxes on cash it hasn’t collected.

The main disadvantage of the cash basis is that financial results in any given period may look distorted. Those distortions can complicate planning and forecasting. Also, cash accounting is not acceptable under GAAP standards. Therefore, any resulting financial statements are considered insufficient by most lenders—and are prohibited for publicly traded companies.

The accrual basis of accounting is the gold standard because it gives a more accurate representation of a company’s finances. With accrual accounting, businesses can more easily keep track of credit transactions using an accounts receivable system, which shows the full transaction history of each customer. An accounts payable system shows the transaction history between your company and a vendor or supplier. GAAP-compliant accrual accounting is required for companies of a certain size, those with certain debt covenants, or that are publicly traded.

A disadvantage of accrual accounting is the additional bookkeeping it incurs. Rather than only tracking cash coming in and out, businesses using accrual accounting monitor receivables, prepaid expenses, accounts payable, and other accrued liabilities. This accounting method also requires more frequent closing of the company’s books. Another disadvantage is that the accrual basis might obscure short-term cash flow issues in a company that looks profitable on paper.

A summary of key differences between the two methods, as well as their advantages and disadvantages, is shown in the chart below.

How Accounting Methods Impact Recording Transactions

When choosing the best accounting method for a business it’s important to understand the impact on bookkeeping—that is, the recording of transactions. Selecting accrual basis, for example, will likely require additional investment in accounting systems and staff expertise.

The cash basis can be supported with single-entry bookkeeping. The single-entry system looks a lot like a personal checkbook, where cash amounts are added or subtracted in one running list or spreadsheet. It’s straightforward and aligns easily with bank withdrawals and deposits. Furthermore, cash accounting does not entail any bookkeeping for assets, liability, or equity.

The accrual basis of accounting requires double-entry bookkeeping, which yields the most accurate and useful financial statements. Double-entry bookkeeping means that accountants record each transaction in two accounts, using a system of debits and credits. These two entries are equal and opposite and, therefore, must balance. At the end of each accounting period, journal entries are added to adjust and reconcile account balances for accrued expenses, deferred revenue, and other transactions that impact assets, liabilities, and equity. Double-entry bookkeeping requires a system of ledgers and journals, most effectively maintained through accounting software. It also requires that the bookkeeper be proficient in understanding GAAP requirements.

Choosing Between Cash- and Accrual-Basis Accounting

Several factors influence the choice between cash- and accrual-basis accounting. Some are a matter of judgment, such as a grasp of how much insight a business owner needs from their books. Others are dictated by law or regulation. Three significant guiding factors include:

• Complexity of the business: The accounting method should reflect the way a company does business. If a business deals primarily in immediate payments for revenue and expenses—whether by actual cash, check, or credit/debit cards—cash basis might be a good fit. Conversely, businesses that extend credit to customers or purchase on credit from their suppliers tend to find that accrual accounting gives a more accurate picture of overall financial health.
• Revenue: Businesses with less than $30 million in gross receipts for the 2024 tax year can choose either of the two methods. The threshold is indexed for inflation. The IRS defines gross receipts as “the total amounts the organization received from all sources during its annual accounting period, without subtracting any costs or expenses.” For details on how to apply the gross receipt test, the IRS guidelines on acceptable accounting methods, entities that are excepted and excluded, and how to change your accounting method, refer to IRS Publication 538.
• GAAP compliance: Whenever a business needs GAAP-compliant financial statements, there is no choice to be made—it must use the accrual basis. This includes all publicly traded companies and non-excluded businesses with more than $30 million in gross receipts for 2024. In practice, it’s common for lenders, investors, and partners to insist on GAAP-compliant financial information, which causes more businesses to use the accrual basis.

When Is It Beneficial to Use Cash-Basis Accounting?

Businesses that use cash for the majority of their transactions may benefit from using the cash basis since it helps keep the accounting uncomplicated and reflects the way the business operates. The cash basis is generally easier to maintain and involves lower administrative costs.

Additionally, many small-business owners elect to use cash accounting because it keeps their cash flow and tax liabilities synchronized. Since cash-basis businesses report income only when it’s actually received and record expenses when they’re paid, they have more flexibility in timing their revenue and deductions. For instance, they might delay sending customer invoices until the following tax year to postpone revenue or choose to pay certain expenses early to claim the deduction in the current year.

When to Use Accrual Accounting

Beyond the legal and regulatory scenarios that require GAAP-compliant financials, there are several situations where accrual accounting may be the better choice. First, whenever there is a lag in converting a sale to cash, such as when businesses extend credit to customers or engage in long-term service agreements, the accrual basis allows revenue to be recognized as it is earned, in whole or in part, even before the cash is received. Similarly, for companies that purchase from suppliers on credit, accrual accounting recognizes the expenses in the accounting period in which they were incurred, which more accurately reflects the true cost of doing business and avoids distorting profits from swings in cash payments. Additionally, businesses that hold large amounts of inventory also benefit from accrual accounting, because it allows the product costs to be capitalized until the time of sale. This maintains the matching of revenue and cost of goods sold (COGS), revealing more accurate gross profit.

Accrual accounting can cause cash flow challenges around tax time, because a company may need to pay taxes on revenue that hasn’t yet been collected from its customer. However, it also offers some tax-planning advantages. For instance, the ability to accrue expenses that were incurred during the tax year but are not yet paid can be a tax benefit for accrual-basis businesses. For example, an accrual-basis business can deduct staff bonuses earned in the current year but paid in the following year.

Effects of Cash and Accrual Accounting

The choice of cash or accrual accounting can affect a company’s cash flow and tax liabilities. It can also shape a business’s policies and processes.

Cash Flow

The cash basis provides immediate visibility of a business’s cash inflows and outflows, making it easier to monitor short-term liquidity. However, it can also create a false sense of security if customer payments come before expenses come due, misleading business leaders about the true amount of available cash reserves.

The accrual basis does a better job of measuring profitability than the cash basis, but it can create challenges for managing cash flow. For example, high revenue tied up in accounts receivable can make a company look profitable but obscure the fact that cash on hand isn’t enough to cover immediate obligations.

Taxes

Cash-basis accounting aligns well with IRS rules that tax revenue when it is received and allow deducting expenses that have been paid during the tax year. This makes compliance uncomplicated. It also gives business owners more control over taxable income by allowing them to manage the timing of cash collections and payments across tax years.

The impact of accrual accounting on taxes is more nuanced. Although there are benefits from accruing expenses incurred but unpaid with regard to lowering taxable income, many small businesses don’t get any benefit because they have little or no such expenses. As a result, it is common for qualified accrual-based small businesses to maintain two sets of books—one that is GAAP-compliant for financial reporting, or “book purposes,” and another that applies the cash basis for tax reporting. The primary challenge is the extra administrative burden of maintaining two sets of books, although leading accounting software can automatically toggle between the methods.

Policies and Processes

The accounting method a business uses affects its internal policies and procedures because it influences how transactions are tracked, how information is reported, and what types of internal controls are necessary. Although cash accounting tends to be simpler, it often requires supplementary processes to manage financial obligations and risks. In contrast, accrual accounting demands more sophisticated systems and oversight.

Companies that use the cash method of accounting:

• Need added processes to stay on top of outstanding customer payments, since there are no accounts receivable ledgers.
• Lack accounts payable tracking and must implement other ways to manage upcoming obligations and avoid missed or late payments.
• Because they deal in mostly cash transactions, they need strong safeguards over incoming and outgoing cash to ensure that it’s not lost or stolen.

Companies that use the accrual method of accounting:

• Implement formal procedures to reconcile bank accounts with accounting records on a regular basis.
• Use forecasting tools to keep tabs on short-term obligations and make sure there are funds to meet them.
• Establish procedures for accounting closes to ensure that all revenue and expense activity is properly included in the right fiscal period.

Hybrid Accounting Method

The hybrid method of accounting blends elements of both cash- and accrual-basis accounting. This approach lets companies use cash accounting for routine transactions, such as daily sales or paying utilities, to simplify cash flow tracking, but apply accrual accounting to more complex areas, such as inventory and long-term contracts.

The benefits of the hybrid approach are that it combines up-to-date cash status with accurate matching of revenues and expenses. Another advantage is that it may also help with tax management by allowing expenses to be deducted when paid and deferring income recognition when appropriate.

However, two significant drawbacks limit its adoption. First, though accepted under US tax law, hybrid accounting isn’t GAAP-compliant. Second, managing dual systems increases administrative demands and raises the risk of errors. Furthermore, it requires comprehensive documentation and consistent application to meet IRS rules and avoid audit flags.

Streamline Your Accounting Process with NetSuite Accounting Software

NetSuite accounting software is a comprehensive, cloud-based accounting platform that automates and streamlines workflows for both cash-basis or accrual accounting. Its flexible chart of accounts simplifies transaction recording and can be customized to keep up with a growing business. The dynamic general ledger supports automated journal entries, data imports, transaction matching, and account reconciliations, reducing the workload on the accounting team and eliminating data entry errors.

NetSuite’s multibook accounting engine gives businesses the ability to maintain parallel books, in compliance with multiple accounting standards, such as tax reporting and GAAP. This allows companies to easily generate reports tailored for different audiences, such as lenders and investors. The system also enforces internal controls through user access and approval permissions, and leverages AI capabilities to detect unusual activity. Additionally, NetSuite’s real-time reporting supports accurate, timely decision-making under either accounting method.

The primary difference between the cash and accrual bases of accounting is the timing of when transactions are recorded in a company’s books. This difference has significant implications for accuracy, cash flow management, taxes, accounting systems, staffing, and reporting compliance. Cash accounting offers simplicity and straightforward cash flow tracking, which is often attractive for smaller businesses. In contrast, accrual accounting results in far greater complexity but provides a more accurate view of financial health—and is the only GAAP-compliant option. Businesses should choose the method that aligns with their needs, supported by the appropriate accounting software, so that the accounting processes are efficient and financial information aids business decision-making.

Cash-Basis vs. Accrual-Basis Accounting FAQs

Who uses cash-basis accounting?

Small businesses often use cash-basis accounting because it is simple and aligns with cash flow. It is commonly used by companies that primarily deal with immediate payments for goods and services, whether paid for with actual cash, checks, or credit/debit cards.

Who uses accrual accounting?

Large businesses and those with complex operations, such as corporations or companies with inventory, typically use accrual accounting. Additionally, it is mandatory for any business that needs to provide financial statements compliant with US Generally Accepted Accounting Principles, which are customarily required by investors, lenders, or partners. It is a requirement for all public companies in the US.

Which is better, accrual- or cash-basis accounting?

Both methods have their pros and cons, depending on a business’s size, complexity, and compliance needs. Cash-basis accounting is simpler to administer and tends to work well for small businesses and those that deal primarily in cash. Accrual accounting provides a more detailed picture of financial health, making it ideal for businesses with more complex transactions or inventory, or that need to comply with US Generally Accepted Accounting Principles.