One of the most common questions I get from small business owners is: Should I use cash-based or accrual-based accounting? The answer isn’t always simple, but understanding the key differences—and knowing when to make the switch—can have a big impact on how well you manage and grow your business.
Before we dive into the differences, let’s get something straight: your main focus as a small business owner should be understanding your business’s financial health, not just optimizing for tax savings. That means using the method that gives you the clearest picture of your revenue, expenses, and profitability.
Spoiler alert: that’s usually accrual-based accounting.
Cash accounting records income and expenses when cash actually moves. This is when you receive payment or when money leaves your account. It's simple, straightforward, and can work fine for very small or early-stage businesses.
But here’s the catch: it doesn’t always give an accurate view of how your business is really performing, especially if your income and expenses don’t align neatly month-to-month. It can make your numbers look more volatile than they are, making it harder to identify meaningful trends.
Accrual accounting, on the other hand, records income and expenses when they are earned or incurred, regardless of when the cash moves. This method provides a more accurate and consistent view of your financial performance by matching revenue to related costs within the same period.
This consistency allows you to track trends, compare months effectively, and better understand margins and break-even points.
If you're serious about managing and growing your business, accrual accounting is typically the way to go—especially if you carry inventory or have multiple income streams.
Let’s say you buy a large batch of inventory in January but don’t sell any of it until March. With cash accounting, that purchase shows up in January, skewing your profitability. With accrual accounting, the cost gets recorded as you sell the inventory, giving you a clear month-by-month gross margin.
That clarity matters. It helps you answer three key questions:
Now, this isn’t to say you should ignore cash. In fact, cash flow is one of the top KPIs you should be tracking. “Cash is king” still holds true—after all, no matter how good your margins look on paper, you can’t pay your bills with accrual profits.
The key is to reconcile your accrual-based profit and loss (P&L) with your actual cash flow so you understand both sides of the story.
Here’s the good news: you can use accrual-based accounting for internal management and still file your taxes on a cash basis. This hybrid approach is common—and often ideal—for small and service-based businesses. It allows you to gain better insight into your business without overcomplicating your tax filings.
If you’re running a business—especially one with inventory or multiple revenue channels—switching to accrual-based accounting as soon as possible is a smart move. It’s the foundation for clearer decision-making, better financial planning, and long-term sustainability.
Just remember:
Understanding your numbers is what enables you to run your business—not just react to it.
