Cash vs accrual accounting: differences with examples

Published Friday 13 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 choose?
• Hybrid methods of accounting
• Cash versus accrual versus hybrid accounting
• FAQs on cash versus accrual accounting

Key takeaways

• Choose cash basis accounting if your business is small with simple transactions and no inventory, as it shows exactly how much cash you have available and lets you pay tax only on money you've actually received.
• Select accrual accounting if you carry inventory, plan to seek funding, or need accurate profitability reports, since it matches income with the expenses that generated it and provides a clearer picture of business performance.
• Recognise that businesses above certain revenue thresholds (like $31 million average annual gross receipts in the US) must use accrual accounting for tax purposes, regardless of their preference.
• Consult with an accountant before switching accounting methods, as the change requires tax authority approval and adjustments to avoid counting income or expenses twice.

Difference between cash and accrual accounting

Cash basis accounting records income and expenses when money changes hands. Accrual basis accounting records them when you earn the income or incur the expense, regardless of when payment occurs.

The key difference is timing: cash basis tracks actual cash flow, while accrual basis tracks financial commitments.

Accrual accounting gives you a more accurate picture of profitability and long-term financial health, which is why major standards like International Financial Reporting Standards (IFRS) require financial statements to be prepared using the accrual basis of accounting. Cash accounting offers simplicity and shows exactly how much money you have available right now.

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 a bill. Unpaid invoices and outstanding bills don't appear in your records until they're settled.

Who uses cash basis accounting?

Cash basis accounting works best for:

• Sole traders and freelancers: Simple transactions and straightforward income tracking
• Small service businesses: No inventory to track and relatively few outstanding invoices
• Businesses under revenue thresholds: Many tax authorities allow cash basis only below certain revenue limits; for example, for tax year 2025, the IRS set the small-business ceiling at $31 million in average annual gross receipts.
• Startups in early stages: When cash flow visibility matters more than long-term financial planning

If your business has inventory, complex transactions, or plans to seek outside funding, accrual accounting may be a better fit.

Benefits of cash accounting

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

Note: Not all businesses can use cash basis accounting for tax purposes. Check with your tax office or accountant.

Downsides of cash accounting

• Incomplete picture: May show profit when you still have unpaid bills, masking your true financial position
• Limited planning insight: Provides only a day-to-day cash view, making it harder to forecast and make strategic decisions

Example of cash basis accounting

Imagine you run a consulting business. In March, you complete a project and invoice your client for $5,000. The client pays you in April.

With cash basis accounting:

• March: No income recorded (you haven't received payment yet)
• April: $5,000 recorded as income (when the money hits your account)

Your March financial reports show no revenue from this project, even though the work was completed.

What is accrual basis accounting?

Accrual basis accounting records income when you earn it and expenses when you incur them, regardless of when cash changes hands. You recognise revenue as soon as you invoice a customer and expenses as soon as you receive a bill, even if payment happens weeks later.

Who uses accrual accounting?

Accrual accounting is typically used by:

• Businesses with inventory: Required to match the cost of goods sold with related revenue
• Companies above revenue thresholds: Many tax authorities require accrual accounting above certain limits
• Businesses seeking funding: Investors and lenders expect accrual-based financial statements
• Companies following Generally Accepted Accounting Principles (GAAP) or IFRS: These standards require accrual accounting

If you're planning for growth, working with investors, or need accurate profitability reports, accrual accounting is usually the better choice.

Benefits of accrual accounting

• Accurate performance tracking: Shows true profitability by matching income with the expenses that generated it
• Better decision-making: Gives you visibility into future cash commitments and expected income
• Easier access to funding: Gives you an advantage with lenders and investors who often prefer accrual-based financial statements

Downsides of accrual accounting

• More complexity: Requires tracking invoices and bills separately from your bank account
• Tax timing mismatch: May require paying tax on income before receiving payment (though you can claim adjustments if customers don't pay)

Example of accrual accounting

Using the same consulting scenario: you complete a project in March and invoice your client for $5,000. The client pays in April.

With accrual accounting:

• March: $5,000 recorded as income (when you earned it by completing the work)
• April: Payment received, but no new income recorded (it was already recognised)

Your March financial reports accurately reflect the revenue you earned that month, giving you a clearer picture of when your business generated value.

Which accounting method should you choose?

The right accounting method depends on your business size, complexity, and goals. Here's how to decide.

Choose cash basis accounting if:

• your business is small with simple, straightforward transactions
• you don't carry inventory
• cash flow visibility is your primary concern
• you're under the revenue threshold for your tax authority

Choose accrual accounting if:

• you carry inventory or have complex transactions
• you're planning to seek loans or investment
• you need accurate profitability reports for decision-making
• your business exceeds revenue thresholds or must follow GAAP

Talk to an accountant if you need help deciding. They can assess your specific situation and recommend the method that works best for your business now and as you grow.

Hybrid methods of accounting

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

Specific rules govern who can use hybrid methods. Talk to an accountant or tax professional to find out what applies to your business.

Cash versus accrual versus hybrid accounting

Accrual accounting gives a clearer picture of business performance by showing when income and expenses actually occurred. If you want to know whether a specific month was profitable, accrual accounting tells you.

Cash basis accounting works well for tracking day-to-day cash flow and can simplify certain tax calculations. However, most growing businesses use accrual as their primary method.

Modern accounting software handles much of the complexity for you. It can automatically record invoices as income when you raise them and track bills as expenses when they arrive. If you use a hybrid approach, the right software lets you switch between views whenever you need.

Xero supports both cash and accrual accounting, making it easy to manage your finances your way. Get one month free and see how simple accounting can be.

FAQs on cash versus accrual accounting

Here are answers to common questions about choosing and using cash versus accrual accounting.

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

Check when your accounting system records income. If it records revenue when you receive payment, you're using cash basis. If it records revenue when you issue an invoice, you're using accrual basis.

Should an LLC use cash or accrual accounting?

Most LLCs can choose either method, as tax authorities like the IRS generally allow smaller businesses to choose between cash or accrual, provided they don't exceed certain revenue thresholds. Cash basis is simpler for small LLCs with straightforward transactions. Accrual basis is better if you have inventory, plan to seek funding, or want more accurate profitability tracking.

Is GAAP accounting accrual or cash basis?

GAAP (Generally Accepted Accounting Principles) requires accrual accounting. If your business must follow GAAP for investors, lenders, or regulatory reasons, you'll need to use accrual basis.

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

Yes, but switching requires adjustments to avoid counting income or expenses twice (or missing them entirely). In the US, you need approval from the tax authority, which involves filing IRS Form 3115 and making a §481(a) adjustment. Work with an accountant to ensure a smooth transition.

How does each method affect my taxes?

Cash basis lets you defer tax on income until you receive payment, which can help cash flow. Accrual basis may require paying tax on income before you've collected it. The best choice depends on your cash flow patterns and overall tax strategy.