Cash vs. Accrual Accounting: Which Is Right for Your Business?

When you’re running a small business, choosing the right bookkeeping method isn't just a compliance issue, it's a strategic decision. One of the most important early decisions you’ll make is whether to use

cash or accrual accounting.

Each method tells a different story about your business’s financial health, and choosing the wrong one can distort your view of profitability, cash flow, and tax obligations.

What Is Cash Accounting?

Cash accounting records income when it’s received and expenses when they’re paid. It’s simple, intuitive, and easy to manage, which makes it a popular choice for freelancers, solopreneurs, and small service-based businesses. It’s otherwise known as “bank feed accounting”, because you only use the bank feed for your bank account to book entries.

Pros of Cash Accounting:

• Easier to understand and implement

• Better real-time snapshot of your cash on hand

• Fewer accounting entries

• Often more tax-friendly for very small businesses

Cons of Cash Accounting:

• Doesn’t show the full picture of income and expenses in the period they actually occur. An example of this is if you ship out goods in December and reduce your inventory and increase your Cost of Goods sold, but you don’t get paid until January, recognizing the income from that sale in the new year.

• Can be misleading for businesses with a lot of receivables or payables. Generally knowing how much you are owed or owe vendors is good practice in case you need to figure out ways to get customers to pay or pay vendors faster.

• Is not Generally Accepted Accounting Principles (GAAP) compliant if you’re looking for investors or funding.

What Is Accrual Accounting?

Accrual accounting recognizes income when it’s earned and expenses when they’re incurred, regardless of when cash changes hands. This provides a more accurate picture of your company’s performance and obligations.

Pros of Accrual Accounting:

• Aligns income with related expenses, showing true profitability

• Better suited for inventory-heavy or fast-growing businesses

• Required for businesses with more than $25M in revenue, per an Internal Revenue Service threshold

• Often preferred by investors or lenders

Cons of Accrual Accounting:

• More complex to maintain due to having to log items before they get paid.

• Can create a misleading sense of available cash if users of financial statements don’t fully understand.

• May require professional bookkeeping or accounting help

When Should You Switch to Accrual Accounting?

If you’re starting to scale, managing inventory, or billing customers on net terms (like Net 15 or Net 30), it might be time to move to accrual accounting.

Common signs it’s time to switch:

• You have sales but don’t understand why cash is low

• You’re seeking outside financing or investment

• You want better insights into business performance

• Your CPA recommends it for tax planning purposes

How This Affects Your Taxes

Your chosen method affects when you report income and expenses, and that affects your tax bill.

• Under cash accounting, you can time income and expenses more easily to manage tax liabilities.

• Under accrual accounting, your financials may reflect higher taxable income even if cash hasn’t hit your account yet.

Some businesses even start on a hybrid method, using accrual for internal reporting and cash for taxes, though this requires more oversight.

Real-Life Examples

Cash method example - You invoice a client for $5,000 in December, but they pay in January. You record the income in January.

Accrual method example - You invoice the same client in December. Under accrual accounting, you record it in December and it’s a receivable, even though the cash arrives next month.

How to Choose the Right Method

Here are a few guiding questions:

• Do you carry inventory?

  
  

Generally, you should start and get into the habit of accrual accounting.

• Do you invoice clients or offer credit terms?

  
  

Due to having receivables, it may be best to use accrual to ensure accurate revenue reporting.

• Are you a solo service provider or consultant?

  
  

Because you are so small in terms of the $25M in revenue, it would be fine to operate on cash basis.

• Are you planning to grow or get funding?

  
  

To be GAAP compliant, you should use accrual to ensure most investors or lenders are understanding of your financials.

Final Thoughts

Choosing between cash and accrual accounting isn’t just an administrative decision, it’s a financial strategy. The method you choose can impact your decision-making, tax planning, and even how attractive your business looks to lenders or investors. If you're unsure which method is right for your business or want help making the switch, Pathfinder Accounting & Tax can help.

We specialize in setting up and maintaining bookkeeping systems that grow with your business. Book a free consultation with us today and get clarity on your financial path forward.