Cash vs accrual accounting: differences and examples

Published Friday 20 February 2026

Table of contents

• What is cash basis accounting?
• What is accrual basis accounting?
• Key differences between cash and accrual accounting
• How cash and accrual accounting work in practice
• When you're required to use accrual accounting
• Which accounting method should you use?
• Hybrid methods of accounting
• Cash versus accrual versus hybrid accounting
• How Xero helps you manage either accounting method
• FAQs on cash versus accrual accounting

Key takeaways

• Choose cash basis accounting if you run a small service business without inventory and want simple bookkeeping that tracks actual money in and out, but recognize it may not show true business performance when bills remain unpaid.
• Use accrual basis accounting when you need accurate monthly profit reports, hold inventory, seek external funding, or exceed tax authority revenue thresholds, as it provides a complete picture of what you earn and owe regardless of payment timing.
• Understand that accrual accounting may show profit on paper while you have little actual cash available, so track cash flow separately to manage day-to-day expenses and avoid liquidity problems.
• Consult an accountant before switching accounting methods, as the change has significant tax implications and may require adjustments to your financial records and reporting processes.

What is cash basis accounting?

Cash basis accounting records income and expenses only when money changes hands. You don't count sent invoices as income or bills as expenses until they're settled.

Despite the name, cash basis accounting has nothing to do with the form of payment you receive. You can be paid electronically and still use cash accounting.

Benefits of cash accounting

Cash basis accounting offers several advantages for small businesses and straightforward operations:

• Simplicity: Shows exactly how much money you have on hand
• Tax timing: You pay tax on money received, not invoices issued, which can help cash flow
• Note: Not all businesses can use cash basis accounting for tax purposes, so check with your tax office

Downsides of cash accounting

Cash basis accounting has limitations that may affect your business as it grows:

• Accuracy issues: May show you as profitable simply because you haven't paid your bills yet
• Limited visibility: Provides only a day-to-day view of finances, making management decisions harder

What is accrual basis accounting?

Accrual basis accounting records income as soon as you raise an invoice and expenses as soon as you receive a bill. Payment timing doesn't matter: a bill due in 30 days is recorded as an expense today.

Benefits of accrual accounting

Accrual accounting provides greater accuracy and supports business growth:

• Accuracy: Provides a complete picture of business performance and finances, which is why in the public sector, high-income jurisdictions currently make up the majority of accrual adopters
• Confident decisions: Supports better financial planning and decision-making
• Financing access: Makes it easier to secure long-term finance from lenders and investors, who rely on reports that adhere to high-quality global accounting standards, which are accrual-based

Downsides of accrual accounting

Accrual accounting requires more effort and has tax implications to consider:

• More admin: Requires tracking invoices and bills, not just your bank account
• Tax timing: You may pay tax on income before receiving payment from customers. If a customer doesn't pay, you can claim the tax back on your next return

Key differences between cash and accrual accounting

The difference between cash and accrual accounting is when you record income and expenses. Cash basis records transactions when money changes hands. Accrual basis records them when you raise an invoice or receive a bill, regardless of when payment occurs.

Accrual accounting gives you a fuller picture of business performance, while cash accounting offers simplicity and clearer visibility of available funds.

How cash and accrual accounting work in practice

The same transaction is recorded differently under each method. These examples show how timing affects your financial statements.

Example: Service business invoice

You complete a consulting project in December and invoice your client for $5,000. They pay you in January.

• Cash basis: You record $5,000 income in January when payment arrives
• Accrual basis: You record $5,000 income in December when you raise the invoice

Example: Expense payment

You receive a $2,000 supplier bill in December. You pay it in January.

• Cash basis: You record $2,000 expense in January when you pay the bill
• Accrual basis: You record $2,000 expense in December when you receive the bill

These timing differences affect which month shows profit or loss on your financial statements.

When you're required to use accrual accounting

Not all businesses can choose their accounting method. Some are required to use accrual accounting based on their size, structure, or reporting requirements.

You may need to use accrual accounting if:

• your business exceeds revenue thresholds: Tax authorities often require accrual accounting above certain income levels
• you hold inventory: Businesses that buy and sell stock typically must use accrual
• you're a C-corporation: Corporate structures often require accrual for compliance
• you need GAAP-compliant reports: Investors, lenders, and auditors usually require accrual-based financial statements, and the SEC has even allowed foreign issuers using the accrual-based IFRS standards to forgo the need to reconcile their financial reports with US GAAP
• you're seeking external funding: Banks and investors expect accrual accounting for accurate performance assessment

Requirements vary by country and jurisdiction. Check with your tax authority or speak to an accountant to confirm which rules apply to your business.

Which accounting method should you use?

The right method depends on your business size, structure, and goals.

Choose cash basis if:

Cash basis accounting works well for certain business types:

• you run a small service business with straightforward transactions
• you don't hold inventory
• you want the simplest approach to bookkeeping
• you prefer to pay tax only on money you've actually received

Choose accrual basis if:

Accrual basis accounting suits businesses with more complex needs:

• you need accurate profit and loss reports by month or quarter
• you hold inventory or have complex transactions
• you're planning to seek funding from investors or lenders
• your business exceeds tax authority revenue thresholds
• you want a complete picture of what you're owed and what you owe

When to consider switching

As your business grows, you may need to change your accounting method. Signs you may have outgrown cash accounting:

• your reports don't reflect your actual business performance
• you're struggling to forecast cash flow accurately
• lenders or investors are requesting accrual-based statements
• your business has grown beyond tax authority thresholds

Switching methods has tax implications. Speak to an accountant before making changes.

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 to simplify certain tax elements.

Rules vary on who can use hybrid methods. Speak to an accountant or tax professional to find out what applies to your business.

Cash versus accrual versus hybrid accounting

Accrual accounting shows when income and expenses occurred, giving you a clearer view of monthly profitability. Cash accounting tracks actual money in and out, helping you monitor cash flow. While many growing businesses use accrual as their primary method, cash accounting remains common for simpler operations and specific tax purposes. For instance, a 2021 report on the public sector found 59% of jurisdictions were still reporting on a cash-basis or a modified form of it.

Accounting software can make accrual accounting much easier to manage. Here's how software simplifies accrual accounting:

• Automated bill entry: Software reads your bills and records expenses automatically
• Invoice tracking: Records income as soon as you raise an invoice
• Flexible reporting: Switch between cash and accrual views whenever you need them

How Xero helps you manage either accounting method

Xero supports both cash and accrual accounting, with features that simplify whichever method you choose. Key features include:

• Automatic transaction recording: Xero captures bills and invoices as they happen
• Flexible reporting: Switch between cash and accrual views with a click
• Bank reconciliation: Match transactions automatically to save time
• Real-time visibility: See your financial position at any moment

Whether you're just starting out or reconsidering your current approach, Xero gives you the flexibility to manage your finances with confidence. Get one month free and see how easy accounting can be.

FAQs on cash versus accrual accounting

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

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

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

Is GAAP accounting accrual or cash basis?

GAAP (Generally Accepted Accounting Principles) requires accrual accounting. Businesses following GAAP standards must record income and expenses when they occur, not when cash changes hands.

Who should not use accrual accounting?

Very small businesses with simple cash transactions and no inventory often find cash accounting simpler and sufficient. If you don't need detailed profit reports or external financing, cash basis may work well.

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

Yes, but switching has tax implications and may require adjustments to your records. Consult an accountant before changing methods to understand the impact on your business.

How does accrual accounting affect my cash flow management?

Accrual accounting shows profit based on invoices and bills, not actual cash. You may show a profit on paper while having little cash available. Track cash flow separately to manage day-to-day liquidity.