Cash accounting vs accrual accounting: Key differences explained

Published Friday 7 November 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 and accrual accounting

Key takeaways

• Choose cash accounting for simple businesses with sales under $500,000 that prioritize tracking current cash flow, but recognize it may show misleading profitability when outstanding bills haven't been paid yet.

• Implement accrual accounting for growing businesses that need to track invoices, manage inventory, or apply for financing, as it provides a complete picture of business performance by recording transactions when they occur rather than when payment happens.

• Recognize that accrual accounting offers superior decision-making capabilities by matching income and expenses to actual business activity, helping you predict future cash flow and understand true monthly profitability.

• Consult with an accountant before switching accounting methods or using hybrid approaches, as IRD requirements vary based on business size and GST registration status, and timing the change at the beginning of a financial year ensures accuracy.

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 records money when it moves. Accrual accounting records income and expenses when they happen.

Why it matters: Accrual accounting shows your full business performance, including profit, financial position, and cash flow. Cash accounting only 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 – electronic transfers, cheques and cash.

How it works:

• Revenue: Only recorded when customers pay you
• Expenses: Only recorded when you pay suppliers
• Outstanding items: Ignored until payment happens

Benefits of cash accounting

• Simplicity: Shows exactly how much money you have available right now
• GST advantages: Easier GST calculations for eligible businesses, which includes those whose total sales are $2 million or less over a 12-month period.

Downsides of cash accounting

• Misleading profitability: Can show false profits if you haven't paid outstanding bills yet
• Limited planning ability: Only shows 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 send an invoice and record expenses when you receive a bill.

How it works:

• Revenue: Recorded immediately when you invoice customers
• Expenses: Recorded when bills arrive, even with 30-day payment terms
• Complete picture: Shows all business activity, including money you're owed and bills you owe

Benefits of accrual accounting

• Accurate performance tracking: Shows true business activity, including unpaid invoices and outstanding bills
• Better decision making: Complete financial picture helps you plan and budget with confidence
• Improved financing options: Banks and lenders prefer the comprehensive view accrual accounting provides

Downsides of accrual accounting

• Increased complexity: Requires tracking invoices and bills, not just bank account movements
• Tax timing issues: You may pay tax on unpaid invoices because, as Inland Revenue (IRD) states, anyone registered for goods and services tax (GST) on an invoice basis must use accrual accounting. You can claim refunds if customers do not pay.

Which accounting method should your business use?

Your business size, structure and goals will help you choose the best accounting method.

Consider cash accounting if:

• You run a very small business or work as a sole trader, such as one with sales under $500,000, which may allow you to file GST less frequently.
• Your business doesn't hold inventory.
• Simplicity is your top priority and you mainly need to track your cash flow.

Consider accrual accounting if:

• Your business is growing and you 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 will want to see a true picture of your profitability.

Hybrid methods of accounting

Hybrid accounting combines both methods – using accrual for business decisions and 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

Important: There are rules about who can use hybrid accounting. The IRD says you must choose to use either accrual or a modified cash basis for income each year. Ask your accountant if hybrid accounting is right for you.

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.

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

Bottom line: Cash accounting works for some businesses, but accrual accounting gives you a clearer view as your business grows. You can try Xero for free to see how it works for you.

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?

Take a look at your financial reports. If you see line items for 'accounts receivable' (unpaid invoices) or 'accounts payable' (unpaid bills), you are using the accrual method. If your reports show income and expenses only when money moves in or out of your bank account, you are using the cash method.

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

The rules for things like goods and services tax (GST) reporting can depend on your business's annual turnover. It's always best to check the IRD website or speak with an accountant or bookkeeper for specific advice that applies to your situation.

Can I switch from cash to accrual accounting later?

Yes, you can, and it's a common step for growing businesses. The best time to switch is at the beginning of a new financial year. Work with an advisor to make sure your transition is smooth and accurate.

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 see your finances your way.