Cash vs accrual accounting: differences and examples

Published Saturday 21 February 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?
• Hybrid methods of accounting
• Choose the right accounting method for your business
• 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 your local tax authority's revenue thresholds, as many require businesses to use accrual accounting once they exceed certain annual income limits, such as the IRS requirement for businesses averaging over $26 million in gross receipts.
• 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: Simpler record-keeping with no inventory to track
• Service-based businesses: Income and expenses align closely with cash flow
• Small businesses under revenue thresholds: Many tax authorities allow cash basis below certain limits; for example, the Internal Revenue Service (IRS) allows it for businesses whose average annual gross receipts for the three prior tax years were $26 million or less.
• Businesses without credit sales: No need to track unpaid invoices

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 $2,000. The client pays you in April.

Under cash basis accounting:

• March: No income recorded (you haven't received payment)
• April: $2,000 income recorded (payment received)

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

Benefits of cash accounting

Cash basis accounting offers advantages for businesses with straightforward finances:

• Simplicity: Shows exactly how much money you have on hand at any time
• Tax timing: Lets you pay tax on money received, not on unpaid invoices, which can improve cash flow

Some businesses must use accrual accounting for tax purposes. Check with your tax office or accountant to confirm eligibility.

Limitations of cash accounting

Cash basis accounting has characteristics that can affect financial clarity:

• Profitability timing gaps: Your books reflect profit based on when cash moves, not when you earn or owe money
• Short-term focus: Day-to-day tracking works best for 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: Matches the cost of goods with the revenue they generate, and in many cases, companies with inventory must use accrual-based accounting for income tax purposes.
• Companies with credit sales: Tracks income when invoiced, not when paid
• Growing businesses seeking finance: Meets lender and investor expectations for accrual-based reports, as accrual accounting is the only method allowed under Generally Accepted Accounting Principles (GAAP) and is required by the Securities and Exchange Commission (SEC) for publicly traded companies.
• Businesses above revenue thresholds: Requires accrual accounting once you exceed certain limits set by many tax authorities

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 $2,000. The client pays in April.

Under accrual accounting:

• March: $2,000 income recorded (invoice raised)
• April: No new income recorded (payment received, but income was already booked)

Your March books show the $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 provides advantages for growing businesses:

• Accurate profitability: Shows true financial performance by matching income with the expenses that generated it
• Better decision-making: Reveals trends and patterns that help you plan ahead
• Easier financing: Meets lender and investor preferences for accrual-based financial statements

Considerations for accrual accounting

Accrual accounting requires more attention to detail:

• More tracking: Requires monitoring outstanding invoices and bills, not just your bank balance
• Tax timing differences: You may owe tax on income before the customer pays, though you can claim it back if the invoice goes unpaid

Which accounting method should you use?

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

• Business complexity: Cash basis suits simpler operations; accrual suits businesses with inventory, credit sales, or multiple revenue streams
• Revenue thresholds: Some tax authorities require accrual accounting once you exceed certain revenue limits
• Financial reporting needs: Lenders and investors typically expect accrual-based statements
• Cash flow visibility: Cash basis shows money on hand; 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.

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 for certain tax calculations.

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 for your business

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.

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, some businesses use hybrid accounting. You might use accrual for financial reporting and cash basis for certain tax calculations. Eligibility depends on your location and business type, so check with your accountant.

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

You may need to switch when you exceed revenue thresholds set by your tax authority, carry inventory, or seek business loans. Lenders and investors typically require accrual-based financial statements.

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.