Cash vs. Accrual: Finding the Right Fit for Your Business

Accounting and Financials
Written By Jelena Allen, CPA

One of the most important tax-related decisions business owners face is choosing an accounting method. While it may seem like a technical choice, the method you use impacts your taxes and financial reporting. The two primary methods are cash basis and accrual basis, with a less common but useful hybrid method available in certain cases.

Let’s break down the differences, advantages, and strategic considerations.

Cash Basis Accounting

The cash basis method of accounting requires income to be recorded when money is received, and expenses when they are paid. It’s straightforward, easy to understand, and often favored by small businesses.

Pros

  • Simple to track – cash in, cash out.

  • Gives a clear picture of actual cash available.

  • Often results in lower accounting fees.

  • May allow for strategic timing of income and expenses to manage tax liability.

Cons

  • Doesn’t show accounts receivable (money owed to you) or accounts payable (bills you owe).

  • It doesn’t track your inventory as an asset.

  • Because it focuses on cash flow it may not provide the most accurate picture of financial health.

  • Not allowed for some businesses, such as C corporations with average gross receipts over $31 million in 2025, per IRS rules.

Accrual Basis Accounting

The accrual method of accounting requires income be recognized when earned - not when collected - and expenses when incurred – not when paid.

Pros

  • Provides a more accurate financial picture, especially for businesses with inventory or significant receivables/payables.

  • Required by GAAP and often preferred for larger or more complex businesses.

  • Helpful for long-term planning and performance measurement.

Cons

  • More complex and requires careful bookkeeping.

  • Can create tax liabilities on income not yet collected.

  • Doesn’t necessarily reflect available cash on hand.

Impact on Taxes

Cash Method: Allows businesses to manage taxable income by timing receipts and payments.

Accrual Method: Can accelerate taxable income since revenue is recognized when earned, even if payment hasn’t been received.

Your choice of method can directly impact your annual tax liability and the strategies available for managing taxable income.

Choosing Your Method: First Tax Return Matters

When you file your very first business tax return, you are effectively locking in your accounting method. The IRS views the method used on that initial return as your chosen method. This makes that first tax return a strategic decision point:

  • A sole proprietor or new LLC might default to cash basis because it’s simpler.

  • A growing business that expects more complex operations may choose accrual from the start to avoid switching later.

  • Businesses with inventory often must use accrual for purchases and sales.

If your business evolves and you later find that your chosen method no longer serves your needs, you can’t just switch on your own. That’s where IRS Form 3115 Application for Change in Accounting Method comes into play.

Switching Methods and Form 3115

Switching accounting methods may make sense if:

  • Your business is growing and operations have become more complex.

  • You’ve outgrown cash basis eligibility under IRS rules.

  • Tax planning opportunities make a different method more advantageous.

How to Switch Properly

A change in accounting method requires IRS approval, generally via Form 3115. Some changes qualify for automatic consent, meaning the IRS doesn’t require a formal ruling. Others require advance permission.

Timing Matters

Sometime switching can defer income recognition, but in other cases it may accelerate taxable income. Work with a CPA to evaluate whether the tax cost of switching outweighs the long-term benefits.

Highlight: The Hybrid Method

Some businesses use a hybrid method, combining elements of both cash and accrual. For example:

  • Recording sales on an accrual basis when earned, but expenses on a cash basis when paid.

  • Using accrual for inventory, required by IRS rules, but cash for everything else.

Benefits of Hybrid Accounting

The hybrid method provides flexibility to match income and expenses more closely to business operations. It can also provide tax advantages by deferring certain expenses or income. And for those businesses with irregular cash flow, such as agriculture or construction, it can be quite useful.

Caution

The IRS places limits on hybrid use, and consistency is key. A hybrid system must clearly reflect income and be applied consistently year-to-year.

Final Thoughts

Choosing between cash and accrual (or even hybrid) isn’t just about compliance – it’s about strategy. The right method can impact your tax bill, the story your financials tell, and your ability to make sound businesses decisions.

It’s also important to note that not every business is eligible to use the cash method. The IRS has specific rules and exceptions based on your entity type, gross receipts, and whether you maintain inventory. These nuances can be critical in determining if cash basis is even an option for your business.

If you’re unsure whether it’s time to switch – or which method fits your growth stage – consult with a CPA who understands both your industry and your long-term goals.

 
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Jelena Allen, CPA