Cash basis vs accrual basis: explained with examples

Published Wednesday 25 February 2026

Table of contents

• What is cash basis accounting?
• What is accrual basis accounting?
• Cash basis vs accrual basis: key differences
• Hybrid methods of accounting
• Which accounting method is right for your business?
• Simplify your accounting with Xero
• FAQs on cash basis vs accrual basis

Key takeaways

• Choose cash basis accounting if you run a small, straightforward business and want simple bookkeeping that tracks actual money on hand, but switch to accrual basis as you grow and need more accurate financial reporting for loans or investors.
• Recognise that accrual accounting records income when you earn it and expenses when you incur them, giving you a complete picture of business performance even when payments haven't been exchanged yet.
• Consider using hybrid accounting methods that combine both approaches, such as accrual for internal decisions and cash basis for simpler tax calculations, but check with your accountant about regional regulations first.
• Understand that businesses with inventory or those offering credit to customers often must use accrual-based accounting due to tax requirements, while most small businesses under $5 million in annual sales can choose either method.

What is cash basis accounting?

Cash basis accounting is a method where you record 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 changes hands.

Despite the name, "cash" doesn't refer to the payment method. You can receive electronic payments and still use cash basis accounting.

Benefits of cash accounting

• Simplicity: Shows exactly how much money you have on hand
• Tax timing: Lets you pay tax only on money you've actually received, not on unpaid invoices
• Cash flow: Helps manage cash flow by matching tax obligations to actual income (check with your tax office, as not all businesses can use cash basis for tax)

Downsides of cash accounting

• Limited accuracy: May show profit simply because you haven't paid your bills yet
• Short-term view: Only reflects day-to-day cash position, making long-term planning harder

What is accrual basis accounting?

Accrual basis accounting records income when you earn it and expenses when you incur them, regardless of when money changes hands. The method is gaining traction globally. Forecasts predict that by 2025, half of the world's public sector jurisdictions will report on accrual basis. You recognise revenue as soon as you raise an invoice, and expenses when you receive a bill, even if payment happens 30 days later.

Benefits of accrual accounting

• Accuracy: Gives you a complete picture of what you've earned and what you owe
• Better decisions: Helps you make financial decisions with more confidence
• Financing: Makes it easier to apply for loans or attract investors

Downsides of accrual accounting

• More admin: Requires tracking invoices and bills, not just your bank balance
• Tax timing: May require paying tax on income before receiving payment
• Unpaid invoices: Lets you claim the tax back on your next return if a customer doesn't pay

Cash basis vs accrual basis: key differences

Cash basis accounting records income and expenses when money changes hands. Accrual basis accounting records them when transactions occur, regardless of when payment happens.

The key difference comes down to timing. Cash basis tracks actual cash flow. Accrual basis tracks what you've earned and owe. Accrual accounting gives you a more complete picture of business performance, but cash accounting has its uses too.

Some businesses combine elements of both approaches.

Hybrid methods of accounting

Hybrid accounting combines elements of both cash and accrual methods. Some businesses use accrual accounting for financial decisions and loan applications, while using cash basis to simplify certain tax calculations.

Rules vary by business type and location. Speak to an accountant or tax professional to find out if hybrid accounting works for your situation.

Which accounting method is right for your business?

Choosing between cash and accrual accounting depends on your business size, complexity, and goals. Here's how to decide which method suits you best.

Consider cash basis accounting if you:

• run a small, straightforward business
• want simple bookkeeping with minimal admin
• need to track actual cash on hand
• qualify to use it for tax purposes in your region

Consider accrual basis accounting if you:

• need accurate profit and loss reporting
• carry inventory or offer credit to customers, as tax rules often require companies with inventory to use accrual-based accounting
• plan to apply for loans or seek investors
• want to track business performance over time

Consider a hybrid approach if you:

• want accrual-based insights for decisions but simpler tax reporting
• meet the regulatory requirements for using both methods

Smart accounting software like Xero handles much of the work for you. It can automatically record invoices as income and bills as expenses on an accrual basis, while still letting you view cash-based reports when needed.

The right tools can help you manage whichever method you choose.

Simplify your accounting with Xero

The right accounting software makes managing your finances easier, regardless of which method you use. Xero supports all accounting methods and automates routine tasks so you can focus on running your business.

Get one month free and see how Xero simplifies your accounting.

FAQs on cash basis vs accrual basis

Still have questions about choosing between cash and accrual accounting? Here are answers to common questions.

Can I switch from cash basis to accrual basis accounting?

Yes, you can switch accounting methods, but you may need approval from your tax authority. For instance, after switching from cash to accrual, a business is often prohibited from making another automatic change for five tax years. Consult an accountant to ensure the transition is handled correctly and doesn't create tax issues.

Which accounting method do most small businesses use?

Most small businesses start with cash basis accounting because it's simpler. Under GAAP, businesses are typically free to choose either method if their annual sales are below $5 million, making the cash basis an attractive option. As businesses grow and need more detailed financial insights, many switch to accrual accounting.

Do I have to use the same method for bookkeeping and taxes?

Not always. Some businesses use accrual accounting for internal reporting and cash basis for tax purposes. Check with your tax office or accountant to confirm what's allowed in your region.

What happens if I choose the wrong accounting method?

You can usually change methods, though it may require adjustments to your records and tax filings. Starting with the simpler cash method and switching later is a common approach for growing businesses.

Does Xero support both cash and accrual accounting methods?

Yes. Xero lets you record transactions on an accrual basis and generate reports in either cash or accrual format, giving you flexibility as your business needs change.