Cash vs accrual accounting: which is right for you?

Published Thursday 9 April 2026

Table of contents

• Difference between cash and accrual accounting
• What is cash basis accounting?
• What is accrual basis accounting?
• Cash vs accrual accounting: key differences at a glance
• Which accounting method should your business use?
• Hybrid methods of accounting
• Making the right choice for your business
• FAQs on cash and accrual accounting

Key takeaways

• Choose cash accounting if you run a small business with sales under $500,000, don't hold inventory, and prioritise simplicity in tracking your current cash position.
• Implement accrual accounting when your business is growing, you need to manage invoices and bills, or you plan to apply for loans since it provides a complete picture of your financial performance.
• Recognise that accrual accounting records income when you earn it and expenses when you incur them, giving you accurate monthly performance data even when payments happen later.
• Switch accounting methods at the start of a new financial year to keep your records clean and work with an accountant to ensure compliance with IRD requirements based on your business size and GST registration.

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.

Accrual accounting shows your full business performance, including profit, financial position, and cash flow. Cash accounting primarily shows your current 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.

Despite the name, cash accounting includes all payment methods, including electronic transfers, cheques, and cash.

How cash accounting works

Cash accounting follows a simple rule: record transactions only when money moves.

• Revenue: Record only when customers pay you
• Expenses: Record only when you pay suppliers
• Outstanding items: Ignore until payment happens

Cash accounting example

Here's how cash accounting records a simple transaction:

You complete a $1,000 project for a client in March and send an invoice. The client pays in April.

• March: No income recorded because no payment received
• April: Record $1,000 income when payment arrives

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

Benefits of cash accounting

Cash accounting offers advantages for smaller, simpler businesses:

• simplicity: Shows exactly how much money you have available right now
• GST advantages: Provides easier GST calculations for eligible businesses with total sales of $2 million or less over a 12-month period

Downsides of cash accounting

Cash accounting has limitations that can affect business decisions:

• misleading profitability: Can show false profits if you haven't paid outstanding bills yet
• limited planning ability: Shows only current cash position, not future commitments or expected income

What is accrual basis accounting?

Accrual accounting records transactions when they happen, not when money changes hands. You record income when you earn it and expenses when you incur them.

How accrual accounting works

Accrual accounting matches income and expenses to when business activity occurs.

• Revenue: Record when you earn it, typically when you invoice customers
• Expenses: Record when bills arrive, even with 30-day payment terms
• Complete picture: Show all business activity, including money you're owed and bills you owe

Accrual accounting example

Here's how accrual accounting records the same transaction:

You complete a $1,000 project for a client in March and send an invoice. The client pays in April.

• March: Record $1,000 income when you send the invoice
• April: Record the payment as settling the accounts receivable balance

Your March financial reports show the revenue when you earned it, giving you an accurate picture of that month's performance.

Benefits of accrual accounting

Accrual accounting provides a more complete view of business performance:

• accurate performance tracking: Shows true business activity, including unpaid invoices and outstanding bills
• better decision making: Provides a complete financial picture to help you plan and budget with confidence
• improved financing options: Gives banks and lenders the comprehensive view they prefer

Downsides of accrual accounting

Accrual accounting requires more effort to maintain:

• increased complexity: Requires tracking invoices and bills, not just bank account movements
• tax timing issues: You may pay tax on income before customers pay you. If you're GST-registered on an invoice basis, IRD requires accrual accounting. You can claim refunds if customers don't pay.

Cash vs accrual accounting: key differences at a glance

Here's a quick comparison of the two methods to help you see the main differences.

When you record income

• Cash: When customers pay you
• Accrual: When you invoice customers

When you record expenses

• Cash: When you pay bills
• Accrual: When you receive bills

What your reports show

• Cash: Current bank balance and recent transactions
• Accrual: Complete picture including unpaid invoices and outstanding bills

Best suited for

• Cash: Small, simple businesses with immediate payment cycles
• Accrual: Growing businesses that invoice customers or hold inventory

Which accounting method should your business use?

Choose your accounting method based on your business size, structure, and goals. Most growing businesses benefit from accrual accounting, while very small businesses may prefer the simplicity of cash accounting.

Consider cash accounting if

Cash accounting works well for straightforward businesses:

• you run a very small business or sole trader operation with sales under $500,000
• you don't hold inventory
• you prioritise simplicity and mainly need to track cash flow

Consider accrual accounting if

Accrual accounting suits businesses with more complex needs:

• you're growing and need to manage invoices and bills
• you sell products and need to track inventory
• you plan to apply for loans or report to investors who want accurate profitability data

Hybrid methods of accounting

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

Common uses include:

• financial planning: Use accrual accounting for loan applications and business analysis
• tax filing: Use cash basis for simplified tax calculations where permitted
• flexibility: Get a complete business picture with easier tax compliance

IRD rules govern who can use hybrid accounting. You must choose either accrual or a modified cash basis for income each year. Ask your accountant if hybrid accounting suits your situation.

Making the right choice for your business

For most businesses, accrual accounting provides the clearest picture of performance because it matches income and expenses to when business activity actually happened. This view is supported by a global trend in the public sector, where leading accounting bodies forecast that 50% of governments will be reporting on an accrual basis by 2025.

Why accrual works better for growing businesses:

• 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 accrual accounting easier to manage:

• automated data entry: Software reads bills and invoices automatically
• real-time updates: Records income as you create invoices
• flexible reporting: Switches between cash and accrual views when needed

Xero makes it easy to manage your finances and gives you a clear, real-time view of your business performance. Get one month free and see how Xero can help streamline your accounting.

FAQs on cash and accrual accounting

Below are answers to common questions about cash and accrual accounting methods.

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

Check your financial reports for accounts receivable or accounts payable line items. If you see these, you're using accrual accounting. If your reports only show transactions when money moves in or out of your bank account, you're using cash accounting.

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

IRD requirements depend on your business size and GST registration. According to the IRD, if your business's turnover exceeds 2 million dollars, you're required to use the invoice (accrual) or hybrid basis for GST. See the IRD GST workshop for more details. Always check the IRD website or speak with an accountant for advice specific to your situation.

Can I switch from cash to accrual accounting later?

Yes, switching is common for growing businesses. The best time to switch is at the start of a new financial year, which keeps your records clean and comparable. Work with an accountant to ensure a smooth transition.

Do I need different software for each accounting method?

No. Xero accounting software lets you run reports using either cash or accrual accounting, so you can view your finances either way without changing your setup.