Accrual vs. Cash-Basis Accounting: What is the Difference?
Learn the difference between accrual and cash-basis accounting, understand when each method is appropriate, and see how your accounting method affects loan applications.
Accrual and cash-basis are the two main accounting methods for recording income and expenses. The method you choose affects when transactions appear on your books, how your financial statements look, and even your tax liability.
Cash-Basis Accounting
With cash-basis accounting, you record income when you receive payment and expenses when you pay them. Money in your bank account directly matches what is on your books.
- Income: Recorded when cash is received
- Expenses: Recorded when cash is paid
- Simplicity: Easy to understand and maintain
- Cash visibility: Books match your actual cash position
Cash-Basis Example
You complete a $10,000 project in December but the client pays in January. With cash-basis, that revenue appears in January when you receive the check.
Accrual Accounting
With accrual accounting, you record income when earned and expenses when incurred, regardless of when cash changes hands. This method matches revenue to the period when the work was performed.
- Income: Recorded when earned (even if not yet paid)
- Expenses: Recorded when incurred (even if not yet paid)
- Accuracy: Better reflects true financial performance
- Complexity: Requires tracking receivables and payables
Accrual Example
Using the same $10,000 project completed in December but paid in January — with accrual accounting, the revenue appears in December when the work was completed.
Comparison Table
Here is a side-by-side comparison of the two methods:
| Factor | Cash-Basis | Accrual |
|---|---|---|
| When to record income | When received | When earned |
| When to record expenses | When paid | When incurred |
| Complexity | Simple | More complex |
| Cash flow visibility | High | Requires separate tracking |
| Revenue-expense matching | May be mismatched | Properly matched |
| Best for | Small, simple businesses | Larger or inventory-based businesses |
Which Method Should You Use?
The IRS allows most small businesses with under $29 million in average annual gross receipts (as of 2024) to use cash-basis accounting. However, businesses with inventory are generally required to use accrual for inventory purchases.
- Use cash-basis if you are a small service business without inventory and want simplicity
- Use accrual if you have significant inventory, receivables, or need accurate period-over-period comparisons
- Some businesses use cash-basis for taxes but accrual for internal management
Impact on Loan Applications
Lenders may view your financials differently depending on your accounting method. Accrual-basis statements show revenue when earned, which may present a stronger picture if you have outstanding receivables.
However, lenders also want to understand your actual cash flow. Be prepared to discuss your accounting method and provide supplementary cash flow information if using accrual accounting.
Whichever method you choose, be consistent. Switching methods can complicate your financial history and raise questions during loan underwriting.
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Read more →Important Disclosure
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