When starting a business, dozens of important decisions need to be made. One of these is choosing the right accounting method. There are a few to choose from, but the two primary methods are accrual accounting and cash accounting. Deciding on which one can shape how you grow in the future.
In this guide, we’ll go through what each method is, their key differences, and the advantages and disadvantages of both, helping you to determine which approach would be the best fit for your business.
What is accrual accounting?
Accrual accounting is an accounting method that records revenue when it is earned and expenses when they are incurred – regardless of when the cash actually changes hands.
One line summary:
- You record income when you sell a product or complete a job, and not when you get paid
- You record expenses when you receive the bill or service, and not when you pay it
This method follows the matching principle, meaning that revenue and expenses are recorded within the same reporting period. Over time, businesses tend to find this method a more complete way of viewing financial performance.
What is cash accounting?
Cash accounting records revenue and expenses when cash is actually received or paid.
One line summary:
- If you haven’t received the cash, you don’t record the revenue
- If you haven’t paid the expenses, you don’t record them
Generally speaking, this method is more straightforward as it focuses explicitly on the actual cash flow of a business. Small businesses and those without accounting resources may find this to be the easiest route forwards.
What are the key differences between cash and accrual accounting?
The core difference between accrual and cash accounting comes down to timing.
| Feature | Accrual Accounting | Cash Accounting |
| Recognising revenue | Only when earned | Only when cash is received |
| Recognising expenses | Only when incurred | Only when cash is paid |
| Financial accuracy | Long-term and comprehensive | Short-term and cash-focused |
| Complexity | More complex | Simpler |
An example of the two
If you provide services in December, this is how it might look based on your accounting method:
- Under accrual accounting, the revenue is recorded in December because that’s when the work was completed.
- Under cash accounting, the revenue is recorded in January because that’s when the payment arrives.
The same timing difference applies to expenses.
What are the advantages and disadvantages of accrual accounting?
Advantages
More accurate financial reporting
Accrual accounting gives a better overall picture of your business profitability by matching income and expenses to the correct period.
Better long-term planning
Because it reflects unpaid invoices and bills, accrual accounting supports more informed forecasting and strategic decision-making.
Compliance with GAAP and IFRS
Accrual accounting is generally required for businesses that need to comply with Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), which are widely recognised accounting standards.
Disadvantages
More time-consuming
It requires tracking receivables, payables, and adjusting entries.
May overstate business position
If a business has many unpaid invoices, revenue may look strong even though cash hasn’t been collected.
Requires greater financial expertise
Understanding and maintaining accrual records often requires a level of professional financial knowledge.
What are the advantages and disadvantages of cash accounting?
Advantages
Easier to understand
Cash accounting is easy to understand and manage, especially for small businesses.
Clear cash flow visibility
It shows exactly how much cash your business has at any given time.
Less financial expertise required
It requires less tracking and fewer adjustments compared to accrual accounting.
Disadvantages
May not accurately reflect long-term financial position
Because it ignores outstanding invoices and unpaid bills, it may not reflect true profitability.
Less effective for forecasting
It doesn’t provide a complete view of future obligations or expected revenue.
May not meet reporting standards
Cash accounting may not comply with GAAP or IFRS requirements.
What are some examples of accrual and cash accounting in action?
Example of accrual accounting
Let’s say a business has completed a consulting project in December and invoices the client, of which payment is received in January.
With accrual accounting:
- Revenue is recorded in December.
- Related expenses are also recorded in December.
- Financial statements accurately reflect the period when the work occurred.
Example of cash accounting
Using the same scenario:
With cash accounting:
- Revenue is recorded in January when payment is received.
- Financial statements show income in January, not December.
This timing difference can significantly impact how monthly or yearly performance appears.
Which method should you choose for your business?
There is no universal answer in choosing accrual vs cash accounting. The right choice depends on:
- Your business size
- The regulatory requirements
- The complexity of transactions
- Your need for financial forecasting
- Your business’ growth plans
Small businesses with straightforward transactions may prefer cash accounting for its simplicity. Companies seeking deeper financial insight – or those required to follow GAAP or IFRS – often use accrual accounting.
Before deciding, it’s wise to consult a financial professional who understands your business structure and long-term goals. With Brixx’s financial forecasting software, you can model both accrual and cash scenarios to see how each method impacts your business before making a final decision. Get started for free today.
