Cash basis vs. accrual accounting: which one should my US business use?

The two methods answer the same question—how much did the business make—at different points in time. Cash basis records income and expenses when money actually moves. Accrual basis records them when they're earned or incurred, regardless of when cash changes hands. Most small businesses start on a cash basis because it's simpler; many are legally required to move to accrual once they cross a certain size, and most that seek outside financing move to accrual well before the law forces them to.

Cash Basis

Accrual Basis

A business can also use a hybrid approach in specific situations—for example, accrual for inventory and cost of goods sold, cash basis for everything else—but this adds complexity and is usually only worth it with professional guidance.

When you're legally required to use accrual

The IRS requires certain businesses to use the accrual method once average annual gross receipts cross a threshold set in the tax code—this threshold is periodically adjusted for inflation, so it's not a fixed number to memorize. C corporations, businesses that carry inventory as a material income-producing factor, and certain other entity types face additional rules on top of the receipts test. Confirm your specific requirement with a CPA rather than assuming your current method is still compliant as revenue grows.

The businesses that get hurt most by this decision aren't the ones on the wrong method — they're the ones that never revisit the decision as they grow. A method that made sense at $200K in revenue can actively mislead you at $2M, long before any legal threshold forces a change.

Signs it's time to move from cash to accrual, even if not required yet

• You're seeking a loan, investor, or line of credit—most lenders and investors expect accrual-based, GAAP-compliant financials before they'll evaluate the business seriously.
• You carry inventory or extend credit to customers—cash basis can badly distort your real profitability once significant unpaid invoices or unsold inventory are in play.
• You're making decisions off numbers that later turn out to be wrong—if your monthly "profit" keeps not matching what actually happens in the bank account, the method itself may be the problem.

For CPA firms specifically

Method changes for existing clients typically require filing Form 3115 with the IRS, along with a Section 481(a) adjustment to account for the transition—this is exactly the kind of task well suited to being scoped out to an outsourced team for calculation and documentation prep, with the firm's CPA handling the filing and client communication.

This is general information, not tax or accounting advice. IRS gross receipts thresholds, entity-specific rules, and method-change procedures are complex and change periodically—confirm your specific requirements and any conversion process with a licensed CPA.