Running a business means making countless decisions, some big, some small. One of the most important choices you’ll face is how to track your finances. Should you use cash accounting or accrual accounting? The answer depends on your business size, industry, and financial complexity.

Let’s break it down so you can make the best decision for your company.

Cash vs. Accrual Accounting: What’s the Difference?

• Cash Accounting: You record income when cash is received and expenses when they’re paid. Simple, right? Perfect for small businesses and freelancers who want straightforward bookkeeping.
• Accrual Accounting: You record income when it’s earned (even if unpaid) and expenses when they’re incurred (even if not yet paid). This method gives a clearer financial picture but requires more effort.

Most startups and small businesses start with cash accounting until growth forces a change.

When Does the IRS Require Accrual Accounting?

The IRS mandates accrual accounting if:
Your average annual revenue exceeds $29 million (based on the last three years).
You’re a publicly traded company with investors or lenders who need transparent financials.

If your business is below this threshold, you have a choice but that doesn’t mean cash accounting is always the best option.

When Should Small Businesses Consider Accrual Accounting?

Even if you’re under the $29M mark, accrual accounting may be smarter if:

• You have high accounts payable (A/P)—accrual can lower taxable income by recognizing expenses earlier.
• You deal with inventory or long-term contracts—cash accounting can distort profitability.
• Lenders or investors require it—they often prefer accrual for accuracy.

But beware: If your accounts receivable (A/R) are higher than payables, accrual accounting could increase your taxable income.

Modified Cash Basis: A Hybrid Approach

Some businesses use modified cash basis accounting—a mix of cash and accrual methods. Here’s how it works:

• Short-term items (daily expenses, sales) → tracked on a cash basis.
• Long-term items (loans, depreciation) → tracked on an accrual basis.

Pros: More detailed than pure cash accounting.
Cons: Not allowed for audited financial statements best for internal use only.

How to Switch from Cash to Accrual Accounting

If you’re ready to transition, here’s what to do:

1. File IRS Form 3115 (Application for Change in Accounting Method).
2. Adjust your books—you can spread a net positive adjustment over four years to ease tax impact.
3. Take a net negative adjustment immediately to reduce taxable income in the current year.

Which Method is Best for You?

Still unsure? Ask yourself:

• How complex are your finances? (More complexity = accrual may be better.)
• Do you carry inventory or have a large A/P? (Accrual gives a truer financial picture.)
• Are investors or lenders involved? (They often prefer accrual.)

The right accounting method can save you money, simplify reporting, and keep the IRS happy. If you’re weighing cash vs. accrual, let’s talk! At MyAccountingGuru, we help businesses choose and implement the best accounting strategy.

📞 Need expert advice? Contact us today!