Cash vs. Accrual Accounting: The Difference, With a Worked Example
Cash basis accounting records revenue when money lands in your bank account and expenses when money leaves it. Accrual basis accounting records revenue when you earn it and expenses when you incur them, regardless of when the cash actually moves.
That one difference is enough to make the same business, in the same month, report either a $21,000 profit or a $2,500 loss. The worked example below shows exactly how.
The short answer
| Cash basis | Accrual basis | |
|---|---|---|
| Revenue is recorded | When the customer pays you | When you deliver the work or the goods |
| Expenses are recorded | When you pay the bill | When you incur the cost |
| Unpaid invoices (A/R) | Invisible | On the books as an asset |
| Unpaid bills (A/P) | Invisible | On the books as a liability |
| What it shows you well | Cash position — what you can actually spend | Profitability and margin |
| What it hides | Whether you're really profitable | Whether you can make payroll Friday |
| Effort to maintain | Low | Moderate — needs real bookkeeping discipline |
| Accepted under GAAP | No | Yes |
| Who typically uses it | Small service businesses, sole proprietors, freelancers | Businesses with inventory, above the gross receipts threshold, or seeking outside capital |
Cash basis answers "what's in the bank?" Accrual answers "did we make money?" Those are different questions, and small businesses get into trouble when they assume the first answers the second.
How different can the same month look?
Take a commercial cleaning company. In March it does the following:
- Bills clients $42,000 for March jobs, on net-30 terms, so the money arrives in April
- Collects $18,000 in March for work it did back in February
- Pays $16,000 in wages to the crews who did the March jobs
- Pays $2,000 in March rent
- Uses $3,000 of supplies on the March jobs, billed by the vendor in March, paid in April
- Pays off February's $2,500 supplies bill
Here is how the two methods report that identical month:
| What happened in March | Cash basis | Accrual basis |
|---|---|---|
| $42,000 invoiced for March work, due in April | — | $42,000 revenue |
| $18,000 collected for February work | $18,000 revenue | — |
| $16,000 payroll for the March jobs | $16,000 expense | $16,000 expense |
| $2,000 March rent | $2,000 expense | $2,000 expense |
| $3,000 supplies used on March jobs, paid in April | — | $3,000 expense |
| $2,500 February supplies bill, paid in March | $2,500 expense | — |
| Reported March profit | –$2,500 | $21,000 |
A $23,500 swing, from the same bank account and the same invoices. Nothing here is fraudulent or even unusual — it is just two different questions being answered.
And in April it reverses. The $42,000 lands, the crews are between contracts, and only $5,000 of new work goes out the door. On cash basis, April looks like a banner month: $42,000 in, roughly $9,000 out (March's supplies bill, April payroll and rent), a $33,000 profit. On accrual, with $5,000 earned against $6,500 of costs incurred, April is a $1,500 loss.
Cash basis called March a disaster and April a triumph. Accrual called it the other way around. Only one of those readings tells you anything about the business.
Why does this matter beyond bookkeeping?
Three practical consequences, in the order they usually bite.
Cash basis can make a profitable business look broke. A growing company that invoices on net-30 or net-60 is constantly funding work before it gets paid for it. On cash basis, every month of growth looks worse than the last, because the costs land now and the revenue lands later. Owners cut marketing and delay hiring on the strength of a number that was never measuring profitability.
It can also make a struggling business look healthy. The mirror image: a business that collects on old receivables while quietly stacking up unpaid bills shows strong cash-basis months right up until the bills come due. The unpaid bills simply do not appear anywhere on a cash-basis profit and loss statement.
Only accrual shows you margin. Matching revenue to the costs that produced it is the whole point of accrual. Because the $16,000 of March payroll and the $3,000 of March supplies sit in the same month as the $42,000 they earned, you can say that March work carried $19,000 of direct cost against $42,000 billed — a gross margin of about 55%. On cash basis those figures land in whichever months the money happened to move, and the margin question has no answer. If you want to know which jobs, services, or customers are worth having, you need accrual. Our guide to reading a profit and loss statement walks through what that report should look like once the matching is done properly.
Who has to use accrual accounting?
Two triggers matter for most small businesses.
Size. The tax code sets a gross receipts test — based on average annual gross receipts over the three prior tax years — above which a business generally cannot use the cash method. The threshold figure is indexed for inflation and moves almost every year, so any specific dollar amount you read online is likely stale. Confirm the current number against IRS guidance or with your accountant before you rely on it. If you are anywhere near it, that conversation is worth having early, because crossing the line is not something you can fix retroactively.
Inventory. Historically, any business that produced, purchased, or sold goods had to account for inventory on accrual. That rule has been substantially relaxed for small business taxpayers who fall under the gross receipts test — they can generally use the cash method and apply simplified inventory treatment. The exceptions have exceptions, so this is worth confirming for your specific situation rather than assuming.
There are also entity-level rules. C corporations and partnerships with a C corporation partner face tighter restrictions, and certain tax shelters are barred from the cash method regardless of size. Personal service corporations and farming businesses have their own carve-outs. If your structure is anything other than a straightforward small LLC, S corp, or sole proprietorship, ask.
Can you use both methods at once?
Yes, and a great many small businesses do. It is completely normal to keep accrual books for managing the business and file taxes on the cash basis.
It works like this. Your bookkeeping software records invoices when you send them and bills when you receive them — that is accrual, and it is what you read every month to see real margin. At year end, your accountant converts to cash basis for the return: back out the accounts receivable you have not collected, back out the accounts payable you have not paid, and file on what actually moved through the bank. Most accounting platforms will toggle a report between the two bases because this is such a common arrangement.
The appeal is a genuine tax-timing benefit. Under cash basis, you are not taxed on December's invoice until January's payment arrives, so a business that ends the year with large receivables defers tax on them by a year. You get accrual's management information and cash's tax timing.
A word on terminology: this in-house arrangement is different from the hybrid method in the tax code, which is a specific permitted combination — for instance, accrual for purchases and sales while using cash for everything else. Both exist, they are not the same thing, and if you intend to file on a hybrid method you want a CPA setting it up, not an internet article.
How do you switch from one to the other?
Not casually, and not unilaterally. Changing your method of accounting for tax purposes generally requires IRS consent, requested on Form 3115, Application for Change in Accounting Method. Some changes qualify for automatic consent procedures and some require advance approval, and the filing has its own deadlines and copy requirements.
The mechanical piece people miss is the adjustment that comes with the change. When you switch, income and expenses that would otherwise be counted twice or skipped entirely have to be trued up in a single catch-up figure. That figure can be substantial, and depending on which direction it runs it may be spread across several tax years rather than hitting one return. Get it wrong and you either overpay or invite an adjustment later.
The practical advice: change methods deliberately, with a CPA, ideally at a year-end boundary and before growth forces it. Switching because you crossed a threshold and got caught is more expensive than switching because you planned to.
What do lenders and investors expect to see?
Accrual. Effectively always.
Underwriters and investors are trying to assess earning power, and cash-basis statements do not show it — they show the timing of your collections. Anyone reading a loan file wants revenue matched to the costs that generated it, receivables and payables on the balance sheet, and periods that compare cleanly. Formal financial statements — a compilation, a review, an audit — are prepared under GAAP, and GAAP means accrual.
So if you expect to raise money, apply for a meaningful credit line, or eventually sell, run accrual books ahead of time. A buyer converts your numbers to accrual anyway; better that you did it, with clean records, than that a due-diligence team does it and finds surprises.
Which should you pick?
If you are a freelancer or small service business, get paid at the point of sale, hold no inventory, and sit comfortably under the gross receipts threshold, cash basis is legitimate and cheaper to maintain.
If you invoice on terms, carry inventory, employ people whose work you bill for later, or plan to borrow or raise capital, run accrual books. The extra bookkeeping cost buys the only version of your numbers that answers the question you actually care about.
If you are in between, run accrual books and file on cash while you are still eligible — the arrangement most well-advised small businesses land on.
What to do next
- Open your accounting software and check which basis your reports are set to. Many owners have never looked, and the default is not always what they assume.
- Run last month's profit and loss on both bases and compare. If the two numbers are close, your timing is simple and the choice barely matters. If they are far apart, you have been making decisions on a number that does not mean what you thought.
- Ask your accountant two specific questions: whether you are still under the current gross receipts threshold, and whether accrual books with cash-basis filing would suit you better than what you have now.
If you do not have someone to ask, this is squarely bookkeeping and reporting work. Of the 13,986 US firms in our directory, 6,464 list bookkeeping among their services and 1,507 specifically list financial statement preparation — the latter being the group most used to producing accrual statements a lender will accept. You can browse bookkeeping services or start with small business accountants near you and filter from there.
Method
Firm counts come from the AccountingNearYou dataset as of 13 August 2026: 13,986 US accounting firms profiled from their own public websites. A firm is counted as offering a service if it names that service on the pages we crawled, so treat these as counts of what firms advertise, not of everything they are willing to do. Firms that offer bookkeeping without publishing it are not counted.
One caveat
This is general information about accounting methods, not tax advice for your business. Method eligibility, the gross receipts threshold, inventory treatment, and the mechanics of a Form 3115 change all turn on specifics — your entity type, your industry, your prior filings — and the threshold figures change from year to year. Confirm anything you plan to act on with a CPA or enrolled agent who has seen your actual books.