Every business keeps its books on one of two methods: cash or accrual. The difference is timing. Both methods count the same sales and the same expenses in the end; they disagree about which month each one belongs to.
That timing changes what your profit and loss statement says, how much tax you pay in a given year, and how lenders read your numbers.
Cash basis accounting
Under the cash method, you record income when money arrives and expenses when money leaves. If you invoice a customer in December and they pay in January, the sale counts in January.
Advantages
- Simple to keep, because the books follow your bank account
- You only pay tax on money you've actually received
- You can shift some income or expenses between years by timing payments, within IRS rules
Drawbacks
- Profit can swing month to month depending on when customers pay and when you pay bills
- It doesn't show what customers owe you or what you owe suppliers
- Lenders and investors usually want accrual-based statements
Accrual accounting
Under the accrual method, you record income when you earn it and expenses when you incur them, whatever day the money moves. The December invoice counts in December, even if the customer pays in January. A bill for December's rent counts in December, even if you pay it later.
Advantages
- Shows true profit for each month, because income is matched with the costs of earning it
- Tracks accounts receivable and accounts payable, so you can see who owes you and whom you owe
- Required under GAAP (generally accepted accounting principles), and preferred by banks and investors
Drawbacks
- More work to keep, because you have to record invoices, bills and adjustments, not just bank activity
- You can owe tax on income you haven't collected yet
- Profit on paper and cash in the bank can be very different, so you need to watch cash flow separately
The same month, both ways
A small business has this December:
- Sent $10,000 of invoices; customers paid $6,000 in December and $4,000 in January
- Received $3,000 of supplier bills; paid $2,000 in December and $1,000 in January
| December | Cash basis | Accrual basis |
|---|---|---|
| Income recorded | $6,000 | $10,000 |
| Expenses recorded | $2,000 | $3,000 |
| Profit for December | $4,000 | $7,000 |
On the cash basis, December profit comes out $3,000 lower, and the remaining $4,000 of income and $1,000 of expenses land in January instead.
Which method can you use for taxes?
Most small businesses can choose. Sole proprietors, S corporations, and partnerships without a corporate partner can generally use the cash method.
The main limit is for C corporations and for partnerships with a C corporation as a partner. They can use the cash method only if their average annual gross receipts for the previous three years are under an IRS threshold. That threshold was $31 million for tax years beginning in 2025, and the IRS adjusts it for inflation each year. Tax shelters can't use the cash method at all.
Two other points:
- Inventory can affect which method you use and how you account for it, so ask your accountant if you sell products.
- Changing methods later generally requires IRS approval, usually by filing Form 3115, so it's worth choosing carefully at the start.
Many small businesses keep their monthly management reports on accrual and file taxes on the cash basis.
How to choose
The cash method usually fits if:
- You're a sole proprietor or a small service business
- Customers pay at the time of sale
- You don't carry much inventory
- You want the simplest bookkeeping
The accrual method usually fits if:
- You invoice customers and wait 30 days or more to get paid
- You carry inventory or large supplier bills
- You plan to borrow money or bring in investors
- You want to know your true profit each month
Switching views in QuickBooks
QuickBooks Online lets you run reports on either basis. On most reports, such as the profit and loss statement, you can choose Cash or Accrual before running it. Your default is set in the account and settings, under the accounting method. This setting only changes how reports are shown. The method you file taxes on is the one on your tax return.
Getting it set up right
The method is usually decided once, at the start, and it shapes how every transaction is recorded after that. If you're not sure which one your books use, or which one you should, I can look at your business and tell you.
I keep books on both methods for small businesses across Texas and the US, all online. See my bookkeeping services and tax preparation, read how to reconcile your bank account, or book a short intro call.
This article is general information, not tax advice for your specific situation. IRS thresholds change every year.