Every business has to decide when to record its income and expenses. The two main approaches, cash accounting and accrual accounting, can paint very different pictures of the same business in the same month. The right choice depends on your size, your industry, the rules where you operate and what you need your numbers to tell you.
Cash accounting in a nutshell
Under cash accounting, you record income when money is received and expenses when they are paid. It is simple, intuitive and closely mirrors your bank balance, which is why many freelancers and very small businesses start here.
The drawback is that it can mislead. A month with lots of customer payments looks highly profitable even if the work was done months ago, while a month in which you paid several annual bills looks like a loss.
Accrual accounting in a nutshell
Under accrual accounting, you record income when you earn it and expenses when you incur them, regardless of when cash changes hands. An invoice raised in March is March income, even if the customer pays in May.
Accruals match income with the costs of producing it, so they show true profitability period by period. That is why larger businesses, companies that hold inventory and most organizations that need audited accounts use this method.
Cash accounting tells you what is in the bank. Accrual accounting tells you how the business is really performing.
Key differences at a glance
| Cash accounting | Accrual accounting | |
|---|---|---|
| Income recorded | When payment is received | When it is earned |
| Expenses recorded | When they are paid | When they are incurred |
| Complexity | Simpler | More involved |
| Shows true profitability | Limited | Yes |
| Typical users | Freelancers and micro businesses | Growing and larger businesses |
How the choice affects tax
In many tax systems, the accounting method affects when income becomes taxable. Cash accounting can delay tax on unpaid invoices, while accruals may bring it forward. Many jurisdictions also restrict who can use the cash basis, often by turnover, business type or legal structure, and switching methods may require notice or adjustments. Always check the rules that apply to you before choosing or changing.
Which method is right for you?
- Cash accounting can suit sole traders, freelancers and small service businesses with simple finances, where it is permitted.
- Accrual accounting suits businesses that hold inventory, offer customers credit, want to borrow or raise investment, or need audited financial statements.
Many growing businesses watch cash day to day while using accruals for their management reports and statutory accounts, which gives them the best of both.
Need help deciding?
Choosing or changing your accounting method has knock-on effects for tax, reporting and financing. Our bookkeeping and tax specialists can review your situation, recommend the right approach and handle any transition for you.
This article is general information only and is not tax, legal or financial advice. Rules differ between jurisdictions and change over time, so please speak to an advisor about your circumstances.
