Cash vs accrual accounting: differences and examples

Published Friday 20 February 2026

Table of contents

• Difference between cash and accrual accounting
• What is cash basis accounting?
• What is accrual basis accounting?
• Which accounting method is right for your business?
• Hybrid methods of accounting
• Manage your accounting with confidence
• FAQs on cash vs accrual accounting

Key takeaways

• Choose cash basis accounting if you run a small business with simple transactions and want to track only actual money in your bank account, but select accrual basis if you need to see the complete financial picture including money owed to you and bills you haven't paid yet.
• Recognize that cash basis accounting records income only when you receive payment and expenses only when you pay bills, while accrual basis records transactions when they occur regardless of when money changes hands.
• Consider that accrual accounting provides more accurate profit and loss reports for decision-making and investor requirements, but requires more administrative work to track invoices and bills beyond your bank balance.
• Check with your tax authority before switching accounting methods, as you'll likely need approval and the change affects how you report income and expenses on your tax returns.

Difference between cash and accrual accounting

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 is timing. With cash basis, you record revenue when you receive payment and expenses when you pay bills. With accrual basis, you record revenue when you earn it (such as when you send an invoice) and expenses when you incur them (such as when you receive a bill).

Each method suits different businesses depending on what they need. Accrual accounting gives you a more complete picture of your financial position, while cash accounting offers simplicity and clearer visibility into your actual cash on hand.

What is cash basis accounting?

Cash basis accounting records transactions only when money physically moves in or out of your business. You recognise income when you receive payment and expenses when you pay bills.

Sent invoices don't count as income until customers pay. Bills don't count as expenses until you settle them.

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

Who uses cash basis accounting?

Cash basis accounting works well for businesses with simple, straightforward transactions, such as:

• sole traders and freelancers: service providers who invoice clients and have few ongoing expenses
• small retail businesses: shops with immediate payment at point of sale
• side businesses: part-time ventures with low transaction volume
• new businesses: startups keeping bookkeeping simple while getting established

Cash basis is most common among businesses that don't carry inventory and don't extend credit to customers. If customers pay you immediately and you pay suppliers on receipt, cash basis may suit your needs.

Example of cash basis accounting

Imagine you're a freelance graphic designer. In March, you complete a logo project and send a £2,000 invoice. The client pays in April.

With cash basis accounting:

• March: no income recorded (you haven't received payment yet)
• April: £2,000 income recorded (payment received)

The same timing applies to expenses. If you receive a £500 software bill in March but pay it in April, you record the expense in April when the money leaves your account.

Your books reflect your actual bank balance, not money you're owed or bills you haven't paid.

Benefits of cash accounting

• Simplicity: shows exactly how much money you have available right now
• Tax timing: lets you pay tax on money you've actually received, not on outstanding invoices
• Cash flow visibility: makes it easier to track what's in your bank account at any given time

Not all businesses can use cash basis accounting for tax purposes. Check with your tax office or accountant to confirm your eligibility.

Downsides of cash accounting

• Incomplete picture: may show profit simply because you haven't paid your bills yet
• Limited planning value: only shows day-to-day cash position, making it harder to forecast or make strategic decisions
• Timing distortions: can make individual months look artificially good or bad when large payments or receipts occur

What is accrual basis accounting?

Accrual basis accounting records transactions when they occur, not when money changes hands. You recognise income when you earn it (such as when you send an invoice) and expenses when you incur them (such as when you receive a bill).

This means your books reflect money you're owed and money you owe, even before payments happen.

Who uses accrual basis accounting?

Accrual basis accounting suits businesses that need a complete picture of their financial position, such as:

• growing businesses: companies scaling up and needing accurate performance tracking
• inventory-based businesses: retailers and manufacturers tracking stock and cost of goods sold
• businesses extending credit: companies that invoice customers with payment terms
• investor-backed companies: businesses required to provide GAAP-compliant financial statements
• larger businesses: companies exceeding cash basis thresholds set by tax authorities

If you regularly have outstanding invoices or unpaid bills, accrual accounting shows your true financial position rather than just your bank balance.

Example of accrual basis accounting

Using the same scenario: you're a freelance graphic designer. In March, you complete a logo project and send a £2,000 invoice. The client pays in April.

With accrual basis accounting:

• March: £2,000 income recorded (you earned it when you completed the work)
• April: no new income recorded (the payment settles the existing receivable)

For expenses, if you receive a £500 software bill in March but pay it in April, you record the expense in March when you incurred the obligation.

Your March profit and loss statement shows the £2,000 income and £500 expense, giving you an accurate picture of that month's performance.

Benefits of accrual accounting

• Accurate financial picture: shows your true profit and loss, including money owed to you and bills you haven't paid yet
• Better decision-making: helps you understand your complete financial position before making business decisions
• Investor and lender readiness: gives you financial statements that banks and investors often require because they follow standardised principles. For example, many non-profits must prepare GAAP-compliant financial statements to meet grant requirements or donor standards.

Downsides of accrual accounting

• More admin: requires you to track invoices and bills, not just your bank balance
• Tax timing mismatch: may mean you owe tax on income before customers actually pay you
• Bad debt complications: requires you to claim back the tax on a future return if a customer never pays

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.

Choose cash basis accounting if:

• your business is small with straightforward transactions
• you're a sole trader or freelancer
• you want the simplest possible bookkeeping
• you need clear visibility into your actual cash position
• your region allows cash basis for tax purposes

Choose accrual basis accounting if:

• you need to track money owed to you and bills you owe
• you want accurate profit and loss reports by time period
• you're seeking loans or investment
• you carry inventory
• your business exceeds cash basis thresholds (check your local tax rules)

Consider hybrid accounting if:

• you want accurate financial reporting plus simplified tax calculations
• your accountant recommends it for your specific situation

Modern accounting software handles most of the complex tasks for you. Tools like Xero automatically record invoices as income when you raise them and track bills as expenses when you receive them. If you need to switch between views, the software can show your finances on either basis.

Some businesses combine both approaches.

Hybrid methods of accounting

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

This approach can give you accurate financial insights plus simplified tax reporting. However, eligibility rules vary by region and business type.

Talk to your accountant or tax professional to find out if hybrid accounting works for your situation.

Manage your accounting with confidence

Choosing the right accounting method helps you understand your business finances and stay compliant with tax requirements. Whether you use cash, accrual, or a hybrid approach, the key is consistency and accuracy.

With cloud-based accounting software like Xero, you can track your finances using either cash or accrual accounting and switch between views whenever you need. The software automatically records transactions for you.

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

FAQs on cash vs accrual accounting

Here are answers to common questions about choosing and using accounting methods.

How do I know which accounting method I'm currently using?

Check how your financial records handle unpaid invoices. If outstanding invoices appear as income, you're using accrual. If income only appears when you receive payment, you're using cash basis. Your accountant or accounting software settings can confirm your method.

Can I switch from cash to accrual accounting (or vice versa)?

Yes, but you'll likely need approval from your tax authority. In the US, this requires filing Form 3115 with the IRS. Switching methods affects how you report income and expenses, so consult your accountant to prevent double-counting or omitting items.

Is accrual accounting required for my business?

It depends on your business size, structure, and location. Many tax authorities require accrual accounting for businesses above certain revenue thresholds or those carrying inventory. For instance, the IRS allows businesses with average annual gross receipts under $30 million to use the cash method, while many larger corporations must use accrual. Check your local tax rules or ask your accountant.

Do most small businesses use cash or accrual accounting?

Small businesses with simple transactions often start with cash basis for its simplicity. As businesses grow and take on inventory, credit customers, or seek investment, many switch to accrual for more accurate financial reporting.

Does my accounting software need to support both methods?

Ideally, yes. Software that supports both methods gives you flexibility as your business evolves. Xero handles both cash and accrual accounting, letting you view reports on either basis without changing your underlying records.