Cash vs Accrual Accounting: Differences and Who Uses Which

The two methods, as the IRS defines them

	Cash method	Accrual method
Income is recorded	In the tax year you actually or constructively receive it	In the tax year you earn it, regardless of when payment is received
Expenses are recorded	In the tax year you actually pay them	In the tax year they are incurred
The test	Did money change hands, or was it made available to you?	Have all events occurred that fix your right to the income (the all-events test), and can the amount be determined?
What it tracks	The bank balance	What the business earned and owes

These are the definitions in IRS Publication 538. "Constructively received" is the clause that trips people up: under the cash method, income counts once it is available to you without restriction, so a cheque that arrives in late December belongs to that year even if it is deposited in January.

One year, two methods

A small design studio in its first year has three events around the year end:

Invoice sent and paid in November: $8,000.
Invoice sent December 20, paid January 15: $12,000.
Annual software bill received in December, paid in January: $2,400.

	Cash method	Accrual method
Income for the year	$8,000	$20,000
Expense for the year	$0	$2,400
Profit for the year	$8,000	$17,600
Where the rest goes	The $12,000 invoice and the $2,400 bill land in next year	Nothing carries over; both belong to this year

Same studio, same work, and a $9,600 difference in reported profit for the year. The cash method shows what reached the bank; the accrual method shows what the year earned. Over the life of the business the totals converge, because every invoice is eventually paid and every bill eventually settled, but any single year can look very different. The invoice generator dates each invoice, which is what the accrual method keys on, and the early payment discount calculator shows what it costs to pull payment into the current year.

Who may use the cash method

Publication 538 lists the businesses that generally may not: a corporation other than an S corporation, a partnership that has such a corporation as a partner, and a tax shelter as defined in section 448(d)(3). The main exception is the gross receipts test: a corporation or partnership that passes it may use the cash method. For tax years beginning in 2026, Revenue Procedure 2025-32 sets the test at average annual gross receipts of $32,000,000 or less for the three tax years before the current one. Qualified personal service corporations are excepted as well. Sole proprietors, most partnerships and S corporations under the threshold can therefore choose, and most small ones choose cash for its simplicity.

The method is chosen on the first tax return and kept until it is changed with IRS consent, which Publication 538 says is generally requested on Form 3115. How businesses that hold inventory account for it is covered in the same publication.

Which one fits

Situation	Leans toward	Why
Freelancer or small service business, paid soon after invoicing	Cash	Simple, and the two methods barely differ when invoices are paid within weeks
Long projects, deposits, retainers or annual contracts	Accrual	Cash timing would make good years look bad and bad years look good
Inventory, suppliers on terms, customers on terms	Accrual	Matching sales to the cost of what was sold is the point of the margin figures
Applying for a loan or bringing in a partner	Accrual statements	Lenders and investors want earned revenue and obligations, not the bank balance
Managing cash week to week	Cash view as well	Accrual profit does not pay salaries; the bank balance does

The two views answer different questions, and a business of any size benefits from both. Accrual figures feed the profit margin calculator, because margin is about the revenue and cost of the same work; the cash view feeds the startup runway calculator, because runway is months of bank balance against monthly outflow. Keeping the books on an accrual basis and filing on a cash basis, when the business qualifies, is a way to have both.

Frequently asked questions

What is the difference between cash and accrual accounting?

When income and expenses are recorded. Under the cash method, IRS Publication 538 says you report income in the tax year you actually or constructively receive it and deduct expenses in the year you pay them. Under the accrual method you report income in the year you earn it, regardless of when payment arrives, and expenses in the year they are incurred.

Which method can a small business use?

Most can choose. Publication 538 says a C corporation, a partnership with a C corporation partner and a tax shelter generally cannot use the cash method, with exceptions for entities that meet the gross receipts test. For tax years beginning in 2026 that test is average annual gross receipts of $32,000,000 or less over the three prior years, per Revenue Procedure 2025-32. Sole proprietors and S corporations below that figure can use either method.

What does "constructively received" mean?

Income counts under the cash method when it is made available to you without restriction, not only when you pick it up. A check that arrives on December 30 is income for that year even if you deposit it in January; interest credited to an account you could withdraw from counts in the year it is credited.

Can I switch methods?

Yes, but a change in accounting method generally needs IRS consent, requested on Form 3115. Publication 538 covers the procedure. The method you pick on your first return is the one you keep until you change it formally, so the choice is worth making deliberately.

Which method shows whether the business is profitable?

Accrual, because it matches revenue to the period it was earned and costs to the period they relate to. Cash accounting shows what happened to the bank balance, which is what you need to know whether you can make payroll. A business can keep its books on an accrual basis for management and file on a cash basis for tax when it qualifies for the cash method.

Sources

Written by Tobias Kurth, designer. Updated October 20, 2026.