Cash basis accounting records income when you receive the money and expenses when you pay them. Accrual accounting records income when you earn it and expenses when you incur them, regardless of when cash actually changes hands. Both are legitimate methods, but they can paint very different pictures of how your business is doing in any given month.

Here’s a simple example. Say you’re a contractor who finishes a $15,000 job in December but the client doesn’t pay until January. Under cash basis, that income shows up in January when the check arrives. Under accrual, it shows up in December when you completed the work and earned the money. Same job, same payment, but it lands in a different period depending on your method. The same logic applies to expenses. If you receive materials in November but don’t pay the supplier until December, cash basis records the expense in December while accrual records it in November.

For most small businesses, cash basis is simpler and more intuitive. You look at your books and see what actually came in and went out. It requires less tracking and gives you a clear picture of your real cash position at any point. Most sole proprietors, single-member LLCs, and small S-Corps use cash basis for exactly this reason.

Accrual gives you a more accurate picture of profitability over time because it matches revenue with the expenses that generated it. Your financial statements reflect the true economic activity of each period rather than just the timing of payments. If you’re making decisions based on monthly profit margins or working with a lender, accrual accounting tells a more complete story. This is especially true for businesses that carry receivables or have significant work in progress.

The IRS requires accrual accounting if your business has average annual gross receipts over $29 million. Below that threshold, most businesses can choose either method. Some industries and entity types have additional rules, so it’s worth confirming which method makes sense for your situation. Choosing the right accounting method early on is part of building a solid financial strategy that supports growth rather than creating headaches down the road.

One thing to watch with cash basis is that it can distort your view of performance. If a big payment comes in one month and nothing the next, your reports will swing wildly even though the underlying work was steady. Accrual smooths that out by recording revenue when earned. On the other hand, accrual can show strong profits on paper while your bank account is running low because clients haven’t paid yet.

Switching between methods after you’ve been operating for a while is possible but requires IRS approval through Form 3115 and can create tax adjustments. It’s better to pick the right method from the start. If you’re not sure which approach fits your business, having a professional handle your full-service bookkeeping means your books are set up correctly from the beginning and your reports actually reflect what you need to see to run your business.