Cash vs Accrual Accounting: Which One Your Small Business Uses
Cash accounting counts money when it moves. Accrual accounting counts it when it's earned or owed. If you run a one-person service business, you're almost certainly using the cash method already, even if nobody ever told you it had a name.
It matters because the same month can show two very different profits depending on which method you use. Neither one is wrong. They're simply answering different questions.
Here's the difference in one worked month, how to tell which you're using, and why it's worth understanding both, even if you only ever file with one.
A Profit and Loss report. The same month can be read two ways. Example data.
The short version
Cash method: income counts when you're paid, expenses when you pay.
Accrual method: income counts when you earn it, expenses when you owe them.
Most sole proprietors without inventory use cash.
Your tax return states which method you use, and changing it needs IRS approval.
The two methods, side by side
Question | Cash | Accrual |
|---|---|---|
When is income counted? | When the money arrives | When the work is done and invoiced |
When are expenses counted? | When you pay them | When the bill arrives |
Does it match your bank account? | Closely | Not month to month |
Does it show what you're owed? | No | Yes |
How much effort? | Low | Higher |
One December, worked both ways
A consultant invoices $8,000 in December. Her clients pay $5,000 of it before the year ends and the other $3,000 in January. She pays $2,000 of expenses in December, and a $600 bill arrives on the 20th that she pays in January.
December | Cash method | Accrual method |
|---|---|---|
Income | $5,000 | $8,000 |
Expenses | $2,000 | $2,600 |
Profit | $3,000 | $5,400 |
Same work, same clients, same month. The cash method says $3,000, because that's what moved. The accrual method says $5,400, because that's what she earned.
Under the cash method the other $2,400 doesn't vanish. It shows up in January, when the $3,000 arrives and the $600 bill is paid.
What each method is good at
Cash tells you what you can spend. It tracks your bank balance, which is the question that matters on the day rent is due.
Accrual tells you how the business actually performed. A month where you did a great deal of work and got paid for none of it looks terrible on a cash basis and excellent on an accrual basis. The truth is the second one, with a timing problem attached.
That timing problem has its own post: the difference between a tax bill and a cash flow problem.
How to tell which one you use
Look at your last tax return. Schedule C asks for your accounting method near the top, with boxes for cash, accrual or other.
Ask how your income was added up. If it was the deposits for the year, that's cash. If it was the invoices you issued, that's accrual.
Ask your preparer. They'll know, and it's a perfectly ordinary question to ask.
Who generally uses which
Kind of business | Common method |
|---|---|
A one-person service business | Cash |
A business that holds significant inventory | Often accrual, at least for purchases and sales |
A larger business, or one with outside investors or lenders | Accrual |
The IRS sets rules about who may use the cash method, and they depend on the size and type of business. For most people reading this blog, the cash method is allowed, and it's what their preparer already uses.
The Report Builder. Dates are what separate the two methods. Example data.
Two details that catch people on the cash method
A check you received in December counts in December, even if you deposit it in January. Income is yours when it's available to you, not when you choose to bank it.
Paying by credit card counts when you charge it, not when you pay the card bill. A December purchase on a card is a December expense.
File on cash, and think in both
You don't have to pick one way of seeing your business. Plenty of owners file on the cash method and still keep an eye on two accrual figures:
What clients owe you. Work done and not yet paid.
What you owe. Bills received and not yet paid.
Cash profit, plus what you're owed, minus what you owe, gets you close to the accrual picture without changing how you file. In the example: $3,000 + $3,000 − $600 = $5,400.
Our post on tracking unpaid invoices covers the first of those two figures.
Can you switch?
Not just by doing it differently next year. Once you've filed using a method, changing it generally requires IRS approval, requested on a specific form. If you think the other method would suit you better, that's a conversation for your preparer, not a setting to change on your own.
Three mistakes to avoid
Mixing the two by accident. Counting income when you invoice but expenses when you pay overstates your profit, and your tax.
Reading a low cash month as a bad month. Check what you're owed first. The work may simply not have been paid for yet.
Holding a check to push income into next year. It counts when you received it, not when you deposit it.
Start with the whole picture, free
What clients owe you is an asset, and what you owe is a debt, so both belong in your net worth. La Soglia, the free membership of the Money Mastery System, holds everything you own and owe in one place, personal and business together, with no bank connection and no card.
Bring your question to the Collective
Not sure which method your books follow? The Money Mastery Collective has a discussion feed open on the free membership. Ask there, and tell us what your preparer said.
Questions we hear
What is the difference between cash and accrual accounting?
Cash counts income when it's received and expenses when they're paid. Accrual counts income when it's earned and expenses when they're owed.
Which accounting method do most small businesses use?
Most one-person service businesses without inventory use the cash method.
How do I know which method I use?
Schedule C of your tax return states it, with boxes for cash, accrual or other. Your preparer can also tell you.
Can I change from cash to accrual?
Generally only with IRS approval, requested on a specific form. Speak to your preparer first.
Does a credit card purchase count when I buy or when I pay the bill?
On the cash method, it counts when you make the charge, not when you pay the card.
References
Accounting methods, when income counts as received, and how to change method are covered in the IRS Instructions for Schedule C (Form 1040) and Publication 538, Accounting Periods and Methods. The December figures are our own worked example.
Related guides: How to do your own bookkeeping, step by step · Home based business bookkeeping: a one-page checklist · Where does my money go? A simple money tracker.
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A note on what this is
This article is educational. The Money Mastery System is an educational tool, not financial software, and nothing here is legal, tax, investment or financial advice. Which accounting method you may or must use depends on your business, and changing it has tax consequences. For guidance on your own circumstances, please speak with a qualified professional who knows them.
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