Cash and accrual are the two methods for deciding when a sale or an expense hits your books. Cash accounting records money when it actually moves. Accrual records it when it’s earned or owed, even if no cash has changed hands yet. Same business, same transactions, different timing, and sometimes a very different picture of a given month. Here’s how each works, a worked example, and which one fits a small business.
The two methods in plain terms
Cash basis: you record income when the money lands in your account and expenses when the money leaves it. If a customer pays you in March, it’s March income. If your insurance bill hits your card in January, it’s a January expense. Simple, and it follows your bank balance closely.
Accrual basis: you record income when you earn it and expenses when you incur them, regardless of when cash moves. Send a $5,000 invoice in March for work you finished in March, and it’s March income even if the client pays in May. Accrual uses accounts receivable (money owed to you) and accounts payable (money you owe) to hold the timing gap.
The same invoice under each method
Say you finish a project on March 28, send a $5,000 invoice that day, and the client pays on May 10. You also incur a $600 subcontractor bill in March that you pay in April. Watch where the numbers land:
| Event | Cash basis | Accrual basis |
|---|---|---|
| $5,000 revenue | May (when paid) | March (when earned) |
| $600 subcontractor cost | April (when paid) | March (when incurred) |
| March profit from this job | $0 | $4,400 |
| May profit from this job | $5,000 | $0 |
Under cash basis, March looks flat and May looks like a great month, even though the work all happened in March. Under accrual, March shows the real $4,400 you earned and the later months show nothing extra. Neither is “wrong.” They just answer different questions: cash tells you what’s in the bank, accrual tells you how the business actually performed.
Pros and cons of each
Cash basis
- Upside: simple to keep, easy to understand, and it mirrors your bank account. You’re taxed on money you’ve actually received, which helps cash flow.
- Downside: it can mislead. A big December deposit for January work makes December look richer than it was, and lumpy months hide the real trend.
Accrual basis
- Upside: it matches revenue to the costs that produced it in the same period, so your monthly numbers reflect real performance. It’s what banks and investors expect to see.
- Downside: more work. You track receivables and payables, and your profit can look healthy in a month when your bank balance is tight because customers haven’t paid yet.
Who should use which?
Most small businesses, freelancers, and sole proprietors use cash basis, because it’s simpler and lines up with how they already think about money. It’s also usually fine with the IRS for smaller operations.
You lean toward accrual when any of these apply:
- You carry inventory as a significant part of the business, which historically pushed businesses toward accrual for those goods.
- You’re a C corporation or a partnership with a C-corp partner above the IRS gross-receipts threshold (an inflation-adjusted figure that has sat around $25 to $30 million in recent years).
- You invoice on terms and want your monthly reports to show performance, not just cash timing.
The exact thresholds and inventory rules move over time and have real nuance, so confirm your situation with a CPA. As a rule of thumb, if you’re a small service business under the gross-receipts limit and carry no meaningful inventory, cash basis is both allowed and easier.
How switching methods works
You generally pick a method with your first tax return and stick with it. Changing later is usually an accounting-method change with the IRS, filed on Form 3115, which includes an adjustment so income isn’t double-counted or skipped in the switch year. It’s doable, but it’s a deliberate filing, not a setting you flip mid-year. Talk to your accountant before you change.
Where LedgerMCP fits
LedgerMCP is real double-entry accounting oriented toward the cash basis most small businesses actually use: you categorize what moves through your bank and card accounts, and your financial reports build straight from those postings. That keeps the books close to your bank reality while staying rigorous, since every entry still has to balance and nothing is ever silently edited. Whichever method you’re on, a clean chart of accounts and an honest profit and loss statement are what make the numbers useful.
Quick answers
Which is simpler, cash or accrual?
Cash, by a wide margin. You record money when it moves, with no receivables or payables to track. It’s why most small businesses choose it.
Which method does the IRS require?
It depends on your structure and size. Many small businesses may use cash basis, but C corporations, businesses over the gross-receipts threshold, and some inventory-heavy operations are generally required to use accrual. Check your specifics with a CPA.
Can I switch from cash to accrual later?
Yes, but it’s a formal accounting-method change, usually filed on Form 3115 with an adjustment in the switch year. It’s not something to do casually, so plan it with your accountant.
Does cash basis mean I’m not doing double-entry?
No. Cash versus accrual is about timing; single versus double entry is about structure. You can and should keep cash-basis books with full double-entry, which is exactly how LedgerMCP works: every transaction still posts balanced debits and credits.