Cash vs accrual accounting: what’s the difference?

Published Monday 26 October 2026

Table of contents

• Difference between cash and accrual accounting
• What is cash basis accounting?
• What is accrual basis accounting?
• Which accounting method should you use?
• Which method does the IRD accept?
• Hybrid methods of accounting
• Choose the right accounting method with Xero
• FAQs on cash vs accrual accounting

Key takeaways

• Choose cash basis accounting if you run a simple business without inventory or credit sales, as it records income and expenses only when money actually changes hands, making it easier to track your available cash.
• Switch to accrual basis accounting when your business grows, carries inventory, or seeks financing, since it records transactions when earned or owed regardless of payment timing and provides a clearer picture of profitability.
• Check how your business is structured before you choose a method. In Hong Kong, incorporated companies must prepare accrual-based financial statements each year under the Companies Ordinance (Cap. 622), and have them audited unless the company is dormant. Unincorporated sole proprietors can keep cash-basis records internally but must keep records sufficient for the Inland Revenue Department (IRD) to assess profits for at least seven years (s51C, Inland Revenue Ordinance).
• Consider using accounting software that supports both methods, allowing you to run cash basis reports for day-to-day cash flow tracking while maintaining accrual records for financial reporting and tax compliance.

Difference between cash and accrual accounting

Cash basis accounting records income and expenses when money changes hands. Accrual basis accounting records them when you raise an invoice or receive a bill, regardless of when payment occurs.

The key difference is timing: cash basis tracks actual cash flow, while accrual basis tracks when transactions are earned or owed.

Accrual accounting gives you a clearer picture of profitability and financial health over time. Cash accounting works well for simpler businesses that need to track day-to-day cash flow.

What is cash basis accounting?

Cash basis accounting records income when you receive payment and expenses when you pay them. Unpaid invoices and outstanding bills don't appear in your books until money actually moves.

The term "cash" refers to timing, not payment method. You can accept electronic payments and still use cash basis accounting.

Who uses cash accounting?

Cash basis accounting works well for:

• sole traders and freelancers, who get simpler record-keeping with no inventory to track
• service-based businesses, whose income and expenses align closely with cash flow
• unincorporated sole proprietors, who keep records for at least seven years under the Inland Revenue Ordinance; companies need accrual-based statements under the Companies Ordinance (Cap. 622)
• businesses without credit sales, which have no unpaid invoices to track

If your business is straightforward and you want to see exactly how much cash you have at any moment, cash accounting may be the right fit.

Example of cash accounting

Imagine you're a freelance graphic designer. In March, you complete a project and invoice your client for HK$2,000. The client pays you in April.

Under cash basis accounting:

• in March, you record no income because you haven't received payment
• in April, you record HK$2,000 income when the payment arrives

Your March books show no income from this project, even though you completed the work. Your April books show the full HK$2,000 when the money arrives.

Benefits of cash accounting

Cash basis accounting offers advantages for businesses with straightforward finances:

• Keeps things simple by showing exactly how much money you have on hand at any time
• Helps you see which invoices have actually been paid, which can support day-to-day cash planning

For Profits Tax, the IRD normally does not accept cash basis, so check with your accountant before relying on cash-basis figures.

Limitations of cash accounting

Cash basis accounting has characteristics that can affect financial clarity:

• Shows profit based on when cash moves, which can differ from when you earn or owe money
• Focuses day-to-day tracking on immediate cash needs rather than longer-term financial patterns

What is accrual basis accounting?

Accrual basis accounting records income when you earn it (when you invoice a customer) and expenses when you incur them (when you receive a bill). Payment timing doesn't affect when transactions appear in your books.

For example, if you invoice a customer in March but they pay in April, you record the income in March under accrual accounting.

Who uses accrual accounting?

Accrual accounting is typically used by:

• businesses with inventory, to match the cost of goods with the revenue they generate
• companies with credit sales, to track income when invoiced rather than when paid
• growing businesses seeking finance, to prepare for lenders, who often ask to see financial statements
• incorporated companies, which must prepare accrual-based financial statements each year and have them audited unless dormant

If you're planning to grow, seek investment, or need a clearer picture of profitability, accrual accounting is usually the better choice.

Example of accrual accounting

Using the same scenario: you're a freelance graphic designer who completes a project in March and invoices your client for HK$2,000. The client pays in April.

Under accrual accounting:

• in March, you record HK$2,000 income when you raise the invoice
• in April, you receive payment but record no new income, as you already booked it in March

Your March books show the HK$2,000 because you earned it that month. Your April books reflect the cash receipt, but the income was already recognised.

Benefits of accrual accounting

Accrual accounting gives you more detail about how your business is performing:

• Shows true financial performance by matching income with the expenses that generated it
• Reveals trends and patterns that help you plan ahead
• Helps you prepare the financial statements lenders often ask to see

Considerations for accrual accounting

Accrual accounting requires more attention to detail:

• Requires you to monitor outstanding invoices and bills as well as your bank balance
• Means a sale is normally taxed in the period you make it, even if unpaid, though you may claim a deduction for proven bad debts

Which accounting method should you use?

Your choice between cash and accrual accounting affects how you track and report your finances. Consider these factors:

• Simpler operations suit cash basis, while businesses with inventory, credit sales, or multiple revenue streams suit accrual
• Incorporated companies in Hong Kong must prepare accrual-based financial statements
• Lenders often ask to see financial statements when you apply for finance
• Cash basis shows money on hand, while accrual shows true profitability

Most growing businesses benefit from accrual accounting. With accounting software like Xero, you can automate much of the work by recording invoices and bills as you create them, and switch views between cash and accrual reporting.

Which method does the IRD accept?

Under its Departmental Interpretation and Practice Notes No. 1, the IRD starts from accrual-based accounts for Profits Tax and normally does not accept cash basis for business profits. That means income is recognised when earned and expenses when incurred, even if the cash moves in a different period.

Cash basis has a narrower role and may suit a sole proprietor's internal records. Every business must still keep sufficient records of income and expenditure for the IRD to ascertain assessable profits, for not less than seven years (s51C). The IRD's guide for unincorporated businesses confirms the law doesn't require a sole proprietorship to use a professional accountant.

Companies formed under the Companies Ordinance must prepare annual financial statements that comply with applicable accounting standards and appoint an auditor each year. The audit is required unless the company is dormant. Your accountant can confirm the right approach for your business.

Hybrid methods of accounting

Hybrid accounting combines elements of both methods. Some businesses use accrual accounting for financial reporting and decision-making, while using cash-basis reports to track day-to-day cash flow. Profits Tax is normally based on accrual accounts.

Eligibility for hybrid accounting depends on your business type, size, and location. Speak to an accountant or tax professional to find out if this approach works for you.

Choose the right accounting method with Xero

While cash basis offers simplicity, accrual accounting provides the detailed insights you need to manage growth and profitability.

You can easily handle either method with Xero. You can run reports on both a cash and accrual basis, giving you a complete view of your finances. This means you can track your day-to-day cash flow while also understanding your long-term performance.

Ready to simplify your bookkeeping? Get one month free.

FAQs on cash vs accrual accounting

Common questions about cash and accrual accounting methods.

Which is better, cash or accrual accounting?

Both methods have their place depending on your business needs. Cash accounting suits simple businesses that want to track money on hand. Accrual accounting suits growing businesses that need accurate profitability reports and may seek financing, as lenders often ask to see financial statements.

How do I know if I'm using cash or accrual accounting?

Check when you record income. If you record it when customers pay, you're using cash basis. If you record it when you invoice, you're using accrual basis. Your accountant or accounting software settings can confirm your method.

Can I use both cash and accrual accounting?

Yes. You can review cash-basis reports for day-to-day planning while keeping the accrual records your accountant uses for Profits Tax.

When do I need to switch from cash to accrual accounting?

You may need to switch when you incorporate your business, carry inventory, or seek business loans. Lenders often ask to see financial statements as part of a loan application.

Does Xero support both cash and accrual accounting?

Yes. Xero lets you run reports on either a cash or accrual basis. You can switch between views at any time without changing your underlying data.