Accrual basis of accounting vs cash basis explained

Published Friday 13 February 2026

Table of contents

• What is accrual basis accounting?
• What is cash basis accounting?
• How accrual accounting works
• Accrual accounting examples
• Cash vs accrual accounting: key differences
• When to use accrual vs cash accounting
• Hybrid methods of accounting
• Simplify your accounting with Xero
• FAQs on accrual basis of accounting

Key takeaways

• Record revenue when you earn it and expenses when you incur them, regardless of when cash changes hands, to get an accurate picture of your business performance and make informed financial decisions.
• Choose accrual accounting if you carry inventory, need accurate profit figures, plan to seek loans or investment, or are required to by tax authorities based on revenue thresholds.
• Consider cash accounting for simple service businesses with few outstanding invoices where you want the easiest possible bookkeeping and need to track actual cash flow closely.
• Consult with an accountant before switching accounting methods or using hybrid approaches, as specific rules vary by jurisdiction and you'll need to adjust records to avoid counting income or expenses twice.

What is accrual basis accounting?

Accrual basis accounting records revenue when you earn it and expenses when you incur them, regardless of when cash changes hands. If you send an invoice in December but receive payment in January, you record the revenue in December. The same applies to expenses: when a bill arrives, you record it immediately, even if you pay 30 days later.

Benefits of accrual accounting

• Gain accuracy: see a true picture of business performance and finances
• Decide with confidence: make financial decisions based on complete data
• Access funding: present accurate financials when applying for loans or investment

Downsides of accrual accounting

• Requires more effort: track invoices and bills, not just your bank balance
• Creates tax timing issues: you may pay tax on income before customers pay you
• Needs adjustment for bad debts: claim tax back if a customer fails to pay

What is cash basis accounting?

Cash basis accounting records income and expenses only when money changes hands. You don't count an invoice as income until the customer pays, and you don't record a bill as an expense until you settle it.

The name refers to timing, not payment method. You can receive electronic payments and still use cash basis accounting.

Benefits of cash accounting

• Stay simple: track only actual money in and out
• See cash position clearly: know exactly how much money you have on hand
• Defer tax payments: pay tax only on money you've received, not invoices you've issued

Downsides of cash accounting

• Distorts profitability: you may appear profitable simply because you haven't paid your bills yet
• Limits planning: you see only day-to-day finances, not the full picture
• Complicates growth: you may struggle to make informed decisions without complete financial data

How accrual accounting works

Accrual accounting follows two core principles: record revenue when earned and record expenses when incurred. Understanding these mechanics helps you apply the method correctly.

Recognising revenue when earned

Recognising revenue means recording income when you complete the work or deliver the product, not when payment arrives. This principle is formally governed by global accounting standards that outline five steps in recognising revenue, starting with identifying the contract and its performance obligations. For example:

• Service business: record revenue when you finish the job, even if the client pays next month
• Product business: record revenue when goods ship or the customer takes possession
• Subscription business: record revenue as you deliver each month of service

This approach shows what you truly earned in any given period.

Recording expenses when incurred

Recognising expenses means recording costs when you receive goods or services, not when you pay the bill. For example:

• Supplier invoice: record the expense when the invoice arrives, not when you pay it
• Utility bill: record the expense for the period it covers, even if billed later
• Employee wages: record wages for the period worked, not the pay date

When you match expenses to the period they relate to, you get accurate profit figures.

Accrual accounting examples

Here's how accrual accounting works in real small business scenarios. These examples show the practical difference between recording transactions when they occur versus when cash changes hands.

Revenue recognition example

A web designer completes a project on 28 December and sends an invoice for $5,000. The client pays on 15 January.

• Accrual accounting: record $5,000 revenue in December (when earned)
• Cash accounting: record $5,000 revenue in January (when paid)

The accrual method shows December as the profitable month, reflecting when the work actually happened.

Expense recognition example

A retailer receives $2,000 worth of inventory on 20 December. The supplier's payment terms are 30 days, so payment goes out on 19 January.

• Accrual accounting: record $2,000 expense in December (when goods received)
• Cash accounting: record $2,000 expense in January (when paid)

The accrual method matches the expense to the period when you received the goods and could sell them.

Cash vs accrual accounting: key differences

The difference between cash and accrual accounting comes down to timing. Each method records revenue and expenses at a different point:

• cash basis: record transactions when money changes hands
• accrual basis: record transactions when you raise an invoice or receive a bill

Accrual accounting gives you a more accurate picture of business performance. Cash accounting is simpler but has limitations.

When to use accrual vs cash accounting

Choosing the right method depends on your business size, industry, and growth plans.

Consider accrual accounting if you:

• carry inventory or have complex transactions
• need accurate monthly or quarterly profit figures
• plan to seek loans or outside investment
• want to track accounts receivable and payable
• are required to by tax authorities (often based on revenue thresholds)

Consider cash accounting if you:

• run a simple service business with few outstanding invoices
• want the easiest possible bookkeeping
• need to track actual cash flow closely
• qualify for cash basis tax reporting in your jurisdiction

Consider hybrid accounting if you:

• need accrual reports for lenders but prefer cash basis for tax
• want flexibility to view finances both ways
• have specific industry or regulatory requirements

Check with your accountant or tax adviser about what's required in your jurisdiction. Some businesses must use accrual accounting once they reach certain revenue thresholds, and on a global scale, International Financial Reporting Standards (IFRS) based on accrual principles are required in 167 countries according to this revenue recognition guide.

Hybrid methods of accounting

Hybrid accounting combines both methods, using accrual for some purposes and cash basis for others. Some businesses use this approach to:

• base major financial decisions on accrual accounting
• simplify tax reporting with cash basis where allowed
• satisfy lender needs while managing day-to-day cash flow

Rules vary by jurisdiction and business type. Speak to an accountant or tax professional to find out what applies to you.

Simplify your accounting with Xero

Whether you choose cash, accrual, or a hybrid method, the right software makes managing your books straightforward. Xero supports all three methods and automates much of the work:

• Record transactions automatically: invoices and bills flow into your accounts as you create them
• Flexible reporting: switch between cash and accrual views with a click
• Reconcile bank transactions: match transactions automatically to save time
• See finances in real time: view your financial position whenever you need it

Ready to streamline your accounting? Get one month free and see how Xero handles cash and accrual accounting for your business.

FAQs on accrual basis of accounting

Here are answers to common questions about accrual accounting.

Can I switch from cash to accrual accounting?

Yes, you can switch methods, but you need to adjust your records to avoid counting income or expenses twice. For example, specific rules may apply, such as the option under U.S. tax law for accrual-based businesses to postpone including the advance payment in income until the next tax year, as outlined in IRS Publication 538. Work with an accountant to transition smoothly and understand how taxes may be affected.

Does my business have to use accrual accounting?

What's required varies by jurisdiction and business size. Many tax authorities require accrual accounting once your revenue exceeds certain thresholds. Check with your accountant or tax office for rules that apply to your business.

How does accrual accounting affect my taxes?

With accrual accounting, you may owe tax on income before customers pay you. This can create cash flow timing issues, but it also gives tax authorities a clearer picture of how your business actually operates.

Can I use both cash and accrual accounting?

Yes, some businesses use a hybrid approach. You might use accrual accounting for financial reporting and management decisions while using cash basis for certain tax purposes where allowed.

Which accounting method does Xero support?

Xero supports cash basis, accrual basis, and hybrid accounting. You can run reports in either method and switch views as needed, so you can flexibly meet different reporting needs.