When you’re starting or growing a small business, choosing an accounting method might not seem urgent. However, the way you record income and expenses impacts everything from your cash flow visibility to your tax obligations. Many business owners come to this crossroads early—especially those who opt for full service bookkeeping help or are preparing to file their first tax return.
There are two primary methods to choose from: cash accounting and accrual accounting. Both are legal and widely used, but one will likely suit your business better based on its size, complexity, and growth plans. In this article, we’ll walk through how each method works, who tends to benefit from each approach, and what switching between them involves.
What Is Cash Accounting?
Cash accounting records income when it’s received and expenses when they’re paid. It’s straightforward and closely aligned with your bank balance. If you send an invoice on May 1 but don’t get paid until June 15, the income is recorded in June under the cash method.
Pros of Cash Accounting
- Simplicity: Cash accounting is easy to understand and manage, especially for new business owners.
- Cash flow clarity: Because transactions are recorded when money actually moves, it’s easier to track available cash.
- Favorable timing for taxes: You can sometimes delay recognizing income (and the taxes owed) until payment is actually received.
Cons of Cash Accounting
- Limited financial picture: Cash accounting can make your view of outstanding income or liabilities less clear.
- Not accepted for some businesses: If your business carries inventory or earns more than $29 million annually (as of current 2025 IRS rules), you may be required to use the accrual method.
What Is Accrual Accounting?
Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when the money changes hands. That same May 1 invoice would be recorded in May, even if the payment doesn’t arrive until June. This method offers a more accurate picture of your financial position over time, which is why it’s standard for larger or more complex businesses.
Pros of Accrual Accounting
- Realistic financial tracking: You get a clearer view of how the business is performing in a given period.
- Better long-term planning: You can match revenue to related expenses, which helps when analyzing profitability.
- Required for some businesses: If you manage inventory or file audited financial statements, the IRS requires accrual accounting.
Cons of Accrual Accounting
- Complexity: The accrual method can be harder to manage without accounting experience.
- Cash disconnect: Your business might look profitable on paper while being short on cash in the bank.
- May require help: Many businesses using accrual accounting rely on full-service bookkeeping or outside accounting professionals.
Which Method Is Right for You?
Here’s a breakdown to help you decide based on typical business scenarios:
- Freelancers and service providers with low overhead
- Use cash accounting. It’s simple to manage and makes it easier to track your available cash in real-time.
- Product-based businesses with inventory
- Use accrual accounting. In many cases, this is required by the IRS because inventory must be matched to sales for accuracy.
- Businesses planning to seek funding or investors
- Use accrual accounting. It provides a more complete financial picture and aligns with GAAP, which most investors prefer.
- Very small businesses with under $1 million in revenue
- Use cash accounting. It’s practical and less complicated for managing everyday business operations.
- Businesses with long payment cycles (e.g., net-30 or net-60 terms)
- Use accrual accounting. It helps you match income and related expenses more accurately across months.
Still not sure which option to choose? You may want to compare software that supports both methods or offers easy transitions between them. Some platforms can show reports in both formats, helping you visualize the differences before committing.
Tax Implications
The IRS allows most small businesses to choose between cash and accrual methods—but once you pick one, you’re expected to stick with it unless you formally apply to change.
- To elect cash accounting, file your taxes that way the first year. No special form is required.
- To switch from cash to accrual or vice versa, file Form 3115 (Application for Change in Accounting Method) with the IRS. This can be a complex process, so many businesses consult a CPA or bookkeeping provider for help. (See the section below on switching methods for more details.)
Be aware that switching methods can affect your taxable income during the year of the change. That’s why it’s important to plan ahead and talk to a tax professional if you’re unsure.
Mixing Accounting Methods (and Why You Probably Shouldn’t)
Some businesses attempt to use a hybrid approach—cash accounting for income and accrual for expenses, or vice versa. While this might seem appealing, the IRS does not officially recognize hybrid methods. Unless you’re working closely with a tax professional, stick to one consistent method to avoid problems during audits or tax filings.
Switching Methods Later
It’s possible to start with cash accounting and switch to accrual later—as your business grows, takes on inventory, or begins preparing for outside funding. This is common and can be a good strategic move.
However, switching methods midstream without preparation can create discrepancies in your books. If you’re thinking about changing approaches, make sure to:
- Close out a full year using the current method.
- Work with a bookkeeper or accountant to reconcile outstanding income and expenses.
- File the correct IRS form (listed above) to report the change.
Choosing between cash and accrual accounting is more than just a technical decision—it affects how you understand your business. Cash accounting is often the right fit for new or very small businesses, while accrual accounting becomes important as you scale or need a more precise financial picture.
If you’re feeling overwhelmed, talking to a bookkeeper or accountant—especially one offering full-service bookkeeping—can help clarify what’s best for your situation. And before you commit, take time to compare software that supports both methods. Having the right tools in place from the start will make your financial management far easier down the line.
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