Cash vs. Accrual Accounting: Which Method Is Best for Your Business?

Have you ever looked at your P&L and wondered, “If I’m showing a profit, why is there no money in the bank?” Or the opposite, where your bank account looks great, but your profit and loss report says you're losing money?

If you're like most small business owners, you've probably heard your accountant mention "cash basis" or "accrual basis" and nodded along without really understanding the difference. And that confusion could be causing you to make poor financial decisions without even realizing it.

In this article, you’ll get a plain-English breakdown of cash vs. accrual accounting, what each method actually means, the pros and cons of each, and how they impact your profitability, tax planning, and long-term business growth.

You’ll also learn how to know when it’s time to switch methods, what a “modified accrual” approach looks like in practice, and how your accounting method could be helping (or hurting) your ability to make good decisions.

What's the Difference Between Cash and Accrual Accounting?

Cash basis accounting means you record money when it moves. You got paid? That's income. You paid a bill? That's an expense. It follows your bank account.

Accrual basis accounting means you record money when it's earned or owed, not when cash changes hands. You invoiced a customer? That's income (even if they haven't paid yet). You received inventory? That's an expense (even if you haven't paid the bill yet).

The difference might sound subtle, but it creates wildly different pictures of your business.

Why The Accounting Method You Use Actually Matters

Let's say you own a restaurant on cash basis accounting. This month, you received a big food shipment from your vendor, but you haven't paid the bill yet because they give you 30-day terms. Your food costs look great this month because you didn't actually pay for that food yet.

Next month, you pay that vendor bill plus this month's shipment. Now your cash basis P&L shows double the food costs, and it looks like you had a terrible month.

But nothing changed about your business performance. The only thing that changed was when you paid the bills.

On accrual basis, both months would show the food costs when you actually received the food. Your financial statements would show what really happened, not just when cash moved.

The Risk of Making Decisions Based on Cash-Basis Financial Statements

The most common issue with cash basis accounting is the "great month, bad month" cycle. You look at your P&L and think, "Wow, expenses were way down!" But you just didn't pay your bills that month. Then everything comes due at once, and it looks terrible.

When your financials swing wildly month after month, you can't identify real trends or make decisions. You're looking at payment timing, not business performance.

We've seen restaurant owners frustrated because their food costs are all over the place. Like 28% one month, 38% the next. Once we switch them to accrual, the real picture emerges. Their food costs are consistently around 33%. That’s not great, but at least now they know the real number and can work on improving it. On cash basis, they were chasing ghosts.

4 Reasons Small Businesses Choose Cash Basis Accounting

To be fair, cash basis isn't wrong for everyone. There are legitimate reasons some businesses use it.

Reason 1: Simplicity

Cash basis is easy to understand. It’s money in, money out. Minimal bookkeeping, no tracking receivables or payables. For a very small, simple business with few transactions, this simplicity means lower accounting costs and less administrative burden.

Reason 2: Tax Timing Benefits

One of the biggest advantages is the ability to control when income gets taxed. It's December and you're about to invoice a client for $20,000? Hold off until January 1st. If you're on cash basis and they pay you in January, that income hits next year's tax return, not this year's. For seasonal businesses or those managing cash flow, this flexibility is valuable.

Reason 3: Cash Flow Clarity

Cash basis shows exactly how much cash you have right now. No confusion about whether income is "real" or just on paper. This works well for service businesses with few receivables or payables, like a consultant who gets paid immediately.

Reason 4: IRS Eligibility

Many small businesses under $30 million in gross receipts (three-year average) qualify to use cash basis. This is especially beneficial for sole proprietors, small service companies, and contractors without inventory.

When cash basis stops working for your business: When you have significant receivables or payables, need an accurate profitability picture, are growing and need financing, or timing differences make your monthly numbers meaningless.

Four Reasons Small Businesses Choose Accrual Accounting Instead

Accrual accounting requires more work, but gives you something cash basis can't: an accurate picture of business performance.

Reason 1: More Accurate Financial Picture

Revenue is recorded when earned, expenses when incurred, not when cash moves. This means your financial statements reflect actual profitability, not just cash timing.

Back to our restaurant example, with accrual accounting:

• You see true food costs in the month you received the food.
• Your labor shows up when employees worked, not when you ran payroll.
• Your revenue shows up when you served customers, not when credit cards deposited money.
• You get a clear picture of what really happened each month.

Reason 2: Essential for Lenders and Investors

Banks and lenders prefer accrual-basis financials because they show the true financial position of your business. If you're applying for an SBA loan or seeking a line of credit, they want to see consistent profitability based on accrual accounting, not just good cash management.

The same goes for investors. They need to understand the real economics—revenue you've earned but not collected, expenses you owe but haven't paid. Cash basis makes your business look artificially good or bad, depending on payment timing.

Reason 3: Supports Complex Businesses

Accrual accounting is essential for companies with significant accounts receivable, large vendor relationships, inventory, or long-term contracts. If your business has any of these characteristics, cash basis simply can't give you the insights you need.

Reason 4: IRS Requirements for Some Businesses

For certain businesses, accrual is IRS-required. This includes C-corporations and partnerships with C-Corp owners over the $30 million threshold, and construction companies with long-term contracts.

When accrual creates challenges: It's more complex to maintain, profit on paper may not match cash in the bank, and it can accelerate taxable income. But for most growing businesses, the insights far outweigh the added complexity.

What is Modified Accrual Accounting and Why Use It?

Here's where things get interesting. Most accountants treat this as all-or-nothing: You're either cash basis or accrual basis. But there's a better approach.

What Modified Accrual Actually Means

At Patrick Accounting, we use modified accrual for monthly financial statements. We accrue the things that are material to your decision-making, and we don't bother accruing things that won't change your decisions.

Let's say you pay business insurance over 10 months instead of 12. Should we accrue that to spread it evenly? Probably not, because knowing whether your insurance was $1,200 or $1,000 this month won't change any decisions.

But for a restaurant, food costs absolutely need to be accrued. If you have $15,000 in unpaid vendor bills, we show that expense so you can see your real food cost percentage and make pricing decisions.

The key principle is materiality. If it matters to your decisions, we accrue it. If it doesn't, we keep it simple.

Using Different Methods for Different Purposes

This may surprise you, but you can use one accounting method for your financial statements and a different method for your tax return. This isn't "two sets of books." It's perfectly legal and smart.

• For monthly financials: We use modified accrual so you have accurate insights for business decisions. Your P&L shows what really happened, so you can identify trends and make informed choices.
• For your tax return: We use whichever method legally minimizes your tax liability. At year-end, we make legal adjustments to convert your books for tax reporting. The IRS allows this.

This means you get financial statements you can make decisions from, the lowest legal tax bill, and no trade-off between insight and tax savings.

How to Know If You're Using the Right Accounting Method

If you're not sure what accounting method your business is using, here's how to figure it out and whether you need to make a change.

Ask Your Accountant Why They Chose That Method

Pick up the phone or send an email and ask: "Are we on cash basis or accrual basis for our monthly financial statements? Why did you choose this method?"

If they give you a clear, thoughtful answer that relates to your specific business, that's a good sign. If the answer is vague, defensive, or "That's just how we do it for all our clients," that’s a red flag. Your accounting method should be chosen based on what your business needs.

Red Flags That You May Be Using the Wrong Accounting Method

• Your financial statements confuse you more than they help.
• Great months and terrible months seem completely random.
• Your bank account doesn't match what your P&L shows (by a lot).
• You can't track who owes you money or what bills you owe.

What Good Accounting Looks Like With the Right Method

When you have the right method in place:

• Your reports are consistent month to month.
• The numbers help you make actual decisions.
• Your accountant can explain what method you're using and why.
• And you understand your financials without needing an accounting degree.

Stop Letting Your Financial Statements Confuse You

At the end of the day, the goal of your accounting method is to gain clarity so you can make informed, confident decisions about your business.

You came to this article because your numbers might not be telling the full story, or you’re unsure if you’re using the right accounting method for your goals.

There's no one "right" answer for every business.

• Cash basis works great for simple operations focused on cash flow and tax timing.
• Accrual basis is essential for businesses with complexity, growth goals, or financing needs.
• And for many businesses, a modified accrual approach for reporting with strategic tax method selection gives you the best of both worlds.

The whole point of financial statements is to help you understand what's happening in your business so you can make better decisions. If your current accounting method is confusing you more than helping you, that's a problem worth solving.

Ready to make sure your accounting method is actually serving your business? 

→ Download our free "Cash vs. Accrual Accounting Guide." It gives you a visual breakdown of the pros and cons, switching criteria, and IRS rules you need to know.
→ Schedule a discovery call. We'll review your current setup and show you how to get clearer, more actionable financials.

At Patrick Accounting, we don’t just report numbers. We help you understand them. And we’ll make sure your accounting method supports the business you’re trying to build.

Because your accounting should help you make money, not just count it.