Should You Use Cash or Accrual Accounting?

Cash vs. Accrual: A Simple Example

Imagine your business earns $1,200 on December 15, but the customer does not actually pay you until January 15.

Cash-Basis Accounting

Under cash-basis accounting, revenue is recorded when the money is actually received.

• December: $0 revenue recorded
• January: $1,200 revenue recorded

The business earned the money in December, but because the customer did not pay until January, the revenue appears in January under the cash method.

Accrual-Basis Accounting

Under accrual accounting, revenue is recorded when it is earned, even if the customer pays later.

• December: $1,200 revenue recorded
• January: $0 additional revenue recorded when the payment is collected

The $1,200 is recognized in December because that is when the business earned it.

The Difference

Cash basis asks: When did the money actually come in?

Accrual basis asks: When was the revenue actually earned?

The business earned the same $1,200 either way. The difference is simply which month the revenue appears in on your financial reports.

What Is Cash-Basis Accounting?

Under cash-basis accounting, income is generally recorded when money is received, and expenses are generally recorded when money is paid.

In simple terms:

Money comes in = income is recorded.

Money goes out = expense is recorded.

For example, imagine you complete a $5,000 project in March but the customer does not pay you until April. Under cash-basis accounting, the $5,000 generally appears as income in April, when you actually receive the money. This approach can be relatively straightforward because it follows the movement of cash.

What Is Accrual-Basis Accounting?

Under accrual accounting, income and expenses are generally recorded when they are earned or incurred, rather than simply when cash changes hands. Using the same example:

You complete a $5,000 project in March and send the customer an invoice. The customer pays you in April. Under accrual accounting, the $5,000 may be recorded as revenue in March, because that is when the revenue was earned.

Until the customer pays, the amount may appear on your Balance Sheet as Accounts Receivable.

A Simple Revenue Example

Suppose your business sends a customer a $10,000 invoice on December 20. The customer pays the invoice on January 10. Under cash-basis accounting:

The $10,000 generally appears as revenue in January. Under accrual-basis accounting:

The $10,000 may appear as revenue in December, when the work was completed and the revenue was earned.

Same transaction.

Different timing.

Expenses Work the Same Way

The difference also applies to expenses. Imagine a vendor completes $3,000 worth of work for your business in June. You receive the bill in June but do not pay it until July.

Under cash-basis accounting, the expense would generally appear when you pay it in July. Under accrual accounting, the expense may be recognized in June, when it was incurred. Until you pay the bill, the amount may appear as Accounts Payable on your Balance Sheet.

Why Does This Matter?

The accounting method you use affects when revenue and expenses appear on your Profit & Loss statement. That means your reported profit can be different depending on whether you are viewing the business on a cash or accrual basis. For example, suppose you invoice customers heavily in December but most of them pay in January.

An accrual-basis P&L may show strong December revenue. A cash-basis P&L may show much less December revenue because the cash has not been collected yet. Neither view necessarily means the other is “wrong.”

They are simply measuring activity differently.

Cash Basis Can Be Easier to Understand

Cash-basis accounting is often easier for business owners to understand because it follows actual cash movements.

You received money.

You record income.

You paid money.

You record an expense. For some small businesses with relatively simple operations, this can make bookkeeping easier to follow. However, it may not always provide the clearest picture of when the business actually earned revenue or incurred expenses.

Accrual Accounting Can Show a Broader Picture

Accrual accounting can provide a more complete view of business activity during a specific period. It allows financial reports to reflect revenue that has been earned even if customers have not paid yet. It can also show expenses that have been incurred even if the bills have not yet been paid.

This can be particularly useful for businesses that:

• Send invoices to customers
• Allow customers time to pay
• Carry inventory
• Receive bills and pay them later
• Want to track Accounts Receivable
• Want to track Accounts Payable

Accrual accounting can help match revenue and related expenses to the periods in which they actually occurred.

Accounts Receivable Is Important Under Accrual Accounting

Accounts Receivable represents money customers owe your business. Suppose you perform $20,000 worth of work this month but customers will not pay until next month. Under accrual accounting, your P&L may show the $20,000 of revenue this month.

Your Balance Sheet may simultaneously show $20,000 in Accounts Receivable. That tells you:

We earned the revenue, but we have not collected the cash yet.

This is one reason profit and cash flow are not always the same thing.

Accounts Payable Works the Other Way

Accounts Payable represents amounts your business owes vendors or suppliers. Suppose a vendor sends you a $5,000 bill today and gives you 30 days to pay. Under accrual accounting, the expense may be recognized now even though the cash will not leave your bank account until later.

Your Balance Sheet would show the amount owed as Accounts Payable until it is paid.

Why Your QuickBooks Reports May Look Different

QuickBooks Online can allow reports to be viewed using either a cash or accrual basis, depending on the report and setup. That means you might open your Profit & Loss statement, switch between accounting methods, and see different numbers. That does not automatically mean something is wrong.

The difference may simply come from transactions such as:

• Unpaid customer invoices
• Unpaid vendor bills
• Payments received in a different period
• Bills paid in a later period

Understanding the accounting method being used is important when reviewing your reports.

Which Method Should a Small Business Use?

There is no single answer that fits every business. A simple service business that receives payment immediately may find cash-basis accounting relatively straightforward. A business that regularly invoices customers, carries inventory, or has substantial unpaid bills may benefit from accrual accounting because it can provide a more complete view of financial activity.

Business structure, tax requirements, industry, revenue, and other factors can also affect which accounting method is appropriate. For tax reporting decisions, it is generally best to confirm the appropriate method with a qualified tax professional or CPA.

Can a Business Look Profitable Under One Method but Not the Other?

Yes, particularly over shorter periods. Imagine your business completes a large amount of work in December but does not collect payment until January. Your accrual-basis December report may show the revenue in December.

Your cash-basis report may not show that revenue until January. As a result, December profit could look significantly different depending on which method you use. Over time, the timing differences may balance out, but they can have a major impact on individual months or reporting periods.

Consistency Matters

Whichever method is appropriate for your business, consistency is important. Switching between cash and accrual reports without realizing it can make comparisons confusing. For example, comparing a cash-basis report from last year with an accrual-basis report from this year may not give you a meaningful comparison.

When reviewing reports, always pay attention to:

• The reporting period
• The accounting method
• Whether the same method was used for the comparison period

The Simplest Way to Remember the Difference

Think of it this way:

Cash accounting asks: “When did the money move?”

Accrual accounting asks: “When was the income earned or the expense incurred?”

That one distinction explains much of the difference between the two methods.

Your Accounting Method Changes How You Read Your Reports

Neither cash nor accrual accounting is simply about changing a setting in QuickBooks. The accounting method affects how you interpret your Profit & Loss statement, Balance Sheet, Accounts Receivable, Accounts Payable, and cash position. Understanding which method you are looking at makes those reports much easier to understand.

At Palmer Ledger, we help U.S. small businesses maintain organized QuickBooks Online records and provide clear financial reports so owners can better understand what is happening in their businesses.