Cash versus accrual accounting explained

Published Wednesday 3 September 2025

Table of Contents

• Difference between cash and accrual accounting
• What is cash basis accounting?
• What is accrual basis accounting?
• Which accounting method should your business use?
• Hybrid methods of accounting
• Making the right choice for your business
• FAQs on cash versus accrual accounting

Key Takeaways

• Choose cash accounting if you run a small business without inventory and want to see your immediate cash position, or select accrual accounting if you need a complete picture of business performance for growth planning and financing applications.
• Recognize that accrual accounting records transactions when they happen (invoicing customers or receiving bills), while cash accounting only records transactions when money actually changes hands.
• Implement accrual accounting to access better financing options and make informed business decisions, as lenders prefer the comprehensive view it provides of all outstanding invoices and bills.
• Consider using hybrid accounting methods to combine accrual for business planning with cash basis for simplified tax calculations, but consult an accountant to ensure compliance with regulations.

Difference between cash and accrual accounting

Cash accounting records transactions when money changes hands. Accrual accounting records transactions when they're earned or incurred, regardless of payment timing.

Key difference: Cash accounting focuses on actual money movement, while accrual accounting captures all business activity when it happens.

Why it matters: Accrual accounting gives you a complete picture of business performance, while cash accounting shows your immediate cash position.

What is cash basis accounting?

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

Important note: Despite the name, cash accounting includes all payment methods – electronic transfers, cheques and cash.

How it works:

• Record revenue only when customers pay you
• Record expenses only when you pay suppliers
• Ignore outstanding items until payment happens

Benefits of cash accounting

• See exactly how much money you have available right now
• Calculate GST more easily if your business is eligible (check IRD requirements for details)

Downsides of cash accounting

• Show false profits if you have unpaid bills
• Limit your ability to plan, as you only see your current cash position

What is accrual basis accounting?

Accrual accounting records transactions when they happen, not when money changes hands. You record income when you send an invoice and expenses when you receive a bill.

How it works:

• Record revenue as soon as you invoice customers
• Record expenses when bills arrive, even if you have 30-day payment terms
• See all business activity, including money owed to you and bills you owe

Benefits of accrual accounting

• Track your business performance accurately, including unpaid invoices and outstanding bills
• Make better decisions with a complete financial picture
• Access more financing options, as banks and lenders prefer the comprehensive view accrual accounting provides

Downsides of accrual accounting

• Track invoices and bills, not just bank account movements, which adds complexity
• Pay tax on unpaid invoices (though you can claim refunds if customers do not pay)

Which accounting method should your business use?

Choosing the right accounting method depends on your business size, structure, and goals. There's no single right answer, but there are some common guidelines.

The cash method often suits you if you run a small business or work for yourself and do not carry inventory. It is simple and lets you see your cash position at a glance.

The accrual method gives you a more accurate, long-term view of your business health. It suits growing businesses, those that manage inventory, or if you plan to apply for financing. Lenders prefer the complete financial picture accrual accounting provides.

Hybrid methods of accounting

Hybrid accounting combines both methods – using accrual for business decisions and the cash basis for certain tax purposes.

Common uses:

• Financial planning: Accrual accounting for loan applications and business analysis
• Tax filing: Cash basis for simplified tax calculations where permitted
• Best of both: Complete business picture plus easier tax compliance

You can only use hybrid methods if you meet certain rules. Check with an accountant to make sure you comply.

Making the right choice for your business

Accrual accounting gives you the clearest picture of your business performance. It matches income and expenses to when business activity happens. As of 2020, about 30 per cent of governments globally reported on an accrual basis.

Why accrual works better:

• True profitability: Shows whether each month was actually profitable
• Complete view: Captures all business activity, not just cash movements
• Better planning: Helps predict future cash flow and business needs

Technology makes it easier:

• Automated data entry: Software reads bills and invoices automatically
• Real-time updates: Income recorded as you create invoices
• Flexible reporting: Switch between cash and accrual views when needed

Most growing businesses benefit from the comprehensive approach of accrual accounting.

Try Xero accounting software for free and see how it can help you manage your business with either method.

FAQs on cash versus accrual accounting

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

Check your financial reports. If your income statement includes accounts receivable (unpaid invoices) and accounts payable (unpaid bills), you're using the accrual method. If it only reflects actual cash that has come in and gone out, you're using the cash method.

What are the IRD requirements for cash vs accrual in New Zealand?

In New Zealand, you can generally use cash basis accounting for GST if your turnover is $2 million or less in a 12-month period; the IRD specifies that this payment basis is available for businesses whose total sales are $2 million or less in the last 12 months. For income tax, most businesses use the accrual method. It's always best to check the latest guidelines on the IRD website or speak with an advisor.

Can I switch from cash to accrual accounting later?

Yes, you can switch from cash to accrual accounting. This is a common step for businesses as they grow and mirrors a global trend where dozens of government jurisdictions are planning for accrual accounting adoption by 2025. You need to adjust for outstanding invoices and bills. Work with an accountant or bookkeeper to make the transition smooth.

Do I need different software for each accounting method?

Not necessarily. Modern accounting software handles both methods. You can switch your reporting view between cash and accrual basis without using separate systems.