Which Is Better: Cash- or Accrual-Based Business Accounting?

Cash vs. accrual accounting

Here’s a quick, at-a-glance comparison of these two accounting methods. 

What is cash-basis accounting?

Cash-basis accounting is an accounting method that records a company’s cash inflows and outflows and then reconciles them. In other words, the business records revenue when cash is received and expenses when payments are made. Unlike accrual accounting, it does not integrate accounts receivable (AR) or accounts payable (AP). These details are typically recorded separately.

Cash-basis accounting is the simpler of the two financial accounting methods. Due to its ease of implementation and straightforward approach, it is often favored by small or early-stage businesses.

Pros and cons of cash-basis accounting

If you’re considering cash-basis accounting for your business, it’s important to understand its benefits and drawbacks.

Pros

• Cash-basis accounting is easy: It is a simpler accounting method, as it requires less information to track. This method is easier for business owners to learn, use and operate.
• Cash-basis accounting lets you see the “here and now”: Cash-basis accounting deals only with concrete funds, so it’s easier to see how much money is on hand. You don’t need to factor in future expenses and income.
• Cash-basis accounting has potential tax advantages: It lets you control the transaction timing, speeding up expenses and slowing down revenue, which can sometimes decrease a company’s tax liability.

Cons

• Cash-basis accounting offers a limited view of finances: Cash-basis accounting provides a great financial snapshot but doesn’t show the complete picture. It doesn’t factor in potential business or customer liabilities, which could also affect decision-making.
• Cash-basis accounting has restricted use: Not everyone can use cash-basis accounting. Companies offering credit to customers, managing inventory or exceeding IRS gross receipt thresholds are required to use accrual accounting.
• It may be difficult to switch from cash-basis accounting to accrual-basis accounting: If your business changes from cash-basis to accrual-basis accounting, you must make adjustments when transitioning your books. You will also have to contact the IRS.

What is accrual-basis accounting?

Accrual-basis accounting is an accounting method that records all transactions when they occur, regardless of when cash is exchanged. It reports a company’s financial results more accurately instead of cash on hand and is a more advanced way to handle business accounting. 

For example, you’d record the associated revenue when you close a sale, not when your customer pays the invoice. You document expenses when your company receives goods or services instead of when you pay the invoice. 

Accrual-basis accounting provides a clearer, more dynamic financial picture of what’s happening in your business.

Pros and cons of accrual-basis accounting

Accrual-basis accounting also has potential advantages and disadvantages.

Pros

• Accrual-basis accounting provides consistency: If expenses and revenue are always recorded at the point of sale, financial planning becomes more predictable. Looking at cash on hand at any given moment doesn’t provide an accurate depiction of your company’s average activity or future inflows or outflows.
• Accrual-basis accounting offers greater financial opportunities: When you apply for business loans, banks and other lenders usually prefer that you use the accrual method of accounting because it provides a clearer picture of financial health.
• Accrual-basis accounting offers better analysis: Aligning revenue and expenses within specific time frames allows for a more accurate analysis of your company’s profitability and financial performance.

Cons

• Accrual-basis accounting can be challenging: Accrual-basis accounting is more complicated, so it can lead to unintentional errors — or worse, deceptive practices, such as hiding accounting mistakes in financial reports.
• Accrual-basis accounting requires staffing: Because it is a more complicated method and requires monthly reports, businesses often need an accounting and finance team (or even an entire department) to manage accrual accounting successfully.
• Accrual-basis accounting has potential tax disadvantages: While accrual-basis accounting allows your business to report income as soon as you make a sale, it also requires you to pay taxes on money you haven’t yet received, which can strain cash flow.

Is cash- or accrual-basis accounting best for my business?

To determine which accounting method best suits your company, assess your current situation and future goals. Start by asking yourself the following question:

1. Is my company required to use the accrual method for tax purposes?

These are some types of companies that are required to use the accrual method for tax compliance: 

• Companies with inventory or goods
• C corporations (unless they meet specific exceptions)
• Businesses with more than $25 million in gross receipts over the last three years (adjusted annually for inflation; talk to a tax consultant to confirm the latest threshold and if it applies to your business)

2. Who needs to know my company’s financial information?

If only a few internal managers examine your financial information for relatively straightforward decision-making, the cash method may be appropriate. However, management will be limited to the financial information available when making decisions. 

In cases where external stakeholders must be privy to your company’s financial information, such as angel investors, banks and advisors, you will want to utilize the accrual accounting method. The accrual method will provide insight into your company’s financial shape and show external stakeholders that the business has the financial savvy to grow.

3. Where do I want my company to be in five years?

If you’re happy with your current transactions and don’t foresee much growth for your business, the cash-basis method could be the right fit. However, if you have a business growth plan to advance your company beyond its current revenues, it’s best to implement the accrual method as soon as possible. 

The accrual method will provide a better picture of your company’s financial results, allowing your internal and external stakeholders to analyze operations more effectively, make more informed decisions and grow the business.

Best accounting software for cash and accrual accounting

The best accounting software can help you maintain compliance and streamline financial management, whether you’re using cash- or accrual-based accounting.

QuickBooks Online

• Cash-basis: Track income and expenses as they occur easily, offering a clear picture of cash flow.
• Accrual-basis: Manage AR and AP, track inventory and generate accurate financial reports.

Read our detailed QuickBooks Online review to learn more.

Xero

• Cash-basis: Simple to set up and use for tracking income and expenses.
• Accrual-basis: Provides features for managing AR, AP and inventory, making it suitable for businesses with complex financial needs.

Our comprehensive review of Xero explains more. 

Zoho Books

• Cash-basis: Tracks income and expenses as they occur, providing a straightforward view of cash flow.
• Accrual-basis: Offers features like invoice management, expense tracking and inventory management, making it suitable for businesses with more complex financial needs.

Check out our updated Zoho Books review for more details.

Transitioning from cash to accrual accounting

Transitioning from cash to accrual accounting can be daunting, especially if your internal accounting resources are limited. In these instances, it may be worth hiring a certified public accountant or seeking guidance from an outsourced accounting team. They can facilitate the transition and provide the ongoing accounting support and financial analysis necessary for you to effectively run your company, analyze your operations and guide your business decisions. 

Mike Berner contributed to this article.