Cash Accounting

Starting a business comes with many decisions, and one of the most important is how you’ll track your finances. The two main accounting methods are cash-based accounting and accrual-based accounting. Choosing the right one can impact how you see your profits, manage your cash flow, and prepare for tax time. Let’s break down both methods in a way that makes sense so you can decide which is best for your business.

What Is Cash Basis Accounting?

Cash basis accounting is the simplest of the two methods. It records income when money is received and expenses when cash is paid. If you get paid today, that income is recorded today. If you pay a bill next week, the cost is recorded next week.

Pros of Cash Basis Accounting:

• Easy to Use – There is no need to track unpaid invoices or bills.
• Clear Cash Flow Picture – You always know exactly how much cash you have.
• Tax Simplicity – You only pay taxes on income you’ve received, which can help with tax planning.

Cons of Cash Basis Accounting:

• Doesn’t Show the Full Picture – Since transactions aren’t recorded until money changes hands, you might think your business is doing better (or worse) than it actually is.
• Limited for Growth – If you plan to scale your business or seek financing, cash accounting might not provide enough detail for banks or investors.

What Is Accrual Basis Accounting?

Accrual-based accounting records income when it’s earned and expenses when incurred, even if the cash hasn’t changed hands yet. If you send an invoice today, it’s recorded as income, even if your client doesn’t pay for another 30 days. Likewise, if you receive a bill, it’s recorded as an expense even if you haven’t paid it yet.

Pros of Accrual Basis Accounting:

• More Accurate Financial Picture – It shows money coming in and going out when it happens, not when it’s paid.
• Better for Growth – Investors, lenders, and large businesses prefer accrual accounting because it provides a clearer view of long-term financial health.
• Required for Some Businesses – If your business earns more than $25 million in revenue (per IRS rules) or carries inventory, you may be required to use accrual accounting. **Check with your tax professional to see if your business needs to use the accrual basis of accounting

Cons of Accrual Basis Accounting:

• More Complex – You’ll need to track accounts receivable (money owed to you) and accounts payable (money you owe), which adds an extra layer of bookkeeping.
• Cash Flow Surprises – Because revenue is recorded before it’s received, you may look profitable on paper but struggle with actual cash.

Which Method Should You Choose?

The right accounting method depends on your business type, size, and goals:

• Cash-based accounting might work best for freelancers, solo entrepreneurs, or small service-based businesses because of its simplicity and clear view of cash flow.
• Accrual accounting is likely the better option if you plan to grow, seek investors, or manage inventory. It provides a more accurate financial picture.
• If you need to track income and expenses for tax deductions, accrual accounting can help ensure everything is accounted for properly.

Final Thoughts

There’s no one-size-fits-all answer, but making the right choice early can save you headaches. If you’re unsure, consulting with an accountant or bookkeeper can help you set up your finances in a way that best supports your business’s success.