Quick answer: Cash accounting records income when money hits your bank account and expenses when you pay them. Accrual accounting records income when you earn it and expenses when you owe them, no matter when cash moves. Most small businesses can use the cash method for taxes if average gross receipts are $32 million or less, and many also review accrual reports to see true monthly profit.
Every business uses an accounting method, even if no one ever told them which one. It decides which month, and which tax year, your income and expenses land in. Here is how to choose with confidence.
How cash basis accounting works
Under the cash method, you record income when you receive payment and expenses when you pay them. If you invoice a client in December and they pay in January, the income counts in January.
- Simple: your books closely match your bank statement.
- Taxed on cash you actually have: you do not owe tax on invoices that are still unpaid.
- Easy to misread: a big payment can make one month look great and the next look terrible.
Good to know: “Cash” does not mean paper money. Checks, card payments, ACH transfers and payment apps all count. An expense paid with a business credit card generally counts when it is charged, not when you pay the card bill.
How accrual basis accounting works
Under the accrual method, you record income when you earn it and expenses when you incur them. That December invoice counts in December, even if the client pays months later.
- Accounts receivable tracks money customers owe you.
- Accounts payable tracks bills you owe vendors.
- Matching: income and the costs of earning it show up in the same month, so profit is more accurate.
The tradeoff is that accrual profit can look healthy while the bank account is empty, because some of that income has not been collected yet.
One business, two methods: a worked example
A consulting firm invoices $10,000 in November and $12,000 in December. One client pays $4,000 in December. The rest, $18,000, arrives in January.
- Accrual: all $22,000 is income this year, because the work was done this year.
- Cash: only $4,000 is income this year. The other $18,000 is income next year.
- Over time the totals match. The method changes timing, not how much income you ultimately report.
Cash vs accrual side by side
| Cash basis | Accrual basis | |
|---|---|---|
| Income recorded | When payment is received | When it is earned |
| Expenses recorded | When paid | When incurred or billed |
| Shows money owed to you | No | Yes, as accounts receivable |
| Shows bills you owe | No | Yes, as accounts payable |
| Allowed under GAAP | No | Yes |
| Effort to maintain | Lower | Higher |
| Best view of | Cash on hand | True profit by month |
| Typical users | Service businesses, freelancers, most small firms | Larger firms, inventory sellers, businesses seeking loans or investors |
What the IRS allows in 2026
The rule: Most small businesses can choose the cash method. For tax years beginning in 2026, C corporations and partnerships with a C corporation partner must generally use accrual once their average annual gross receipts for the prior three tax years exceed $32 million.
- The same test lets small businesses skip more complex inventory accounting rules.
- Tax shelters cannot use the cash method, no matter how small they are.
- Be consistent. Your first return sets your method. You cannot simply switch from year to year.
- Virginia follows your federal method, since your Virginia return starts from your federal income.
Sole proprietors, S corps and partnerships without a C corporation partner are not forced onto accrual by this limit, though the same test still matters for inventory rules.
How your accounting method affects your taxes
On the cash method you have some control over timing near the end of the year, which can help you manage which year income lands in.
- Paying expenses before December 31 generally makes them deductible this year.
- Prepaid expenses are usually deductible right away only if the benefit lasts no more than 12 months and does not extend past the end of next year. Otherwise they are spread out.
- Constructive receipt: a check you receive in December is income in December, even if you deposit it in January. You cannot hold a payment to push income into next year.
- Accrual businesses generally deduct expenses when the bill is owed and the service or goods are received, and report income once it is earned, even if unpaid.
Tip: Timing only shifts tax between years. It helps most when you expect a lower income year next year. Our tax planning service models this before you act.
Modified cash and hybrid methods
Many small businesses do not use a pure version of either method.
- Modified cash basis: mostly cash, but equipment is recorded as an asset and depreciated, loans are recorded as liabilities and payroll taxes owed are tracked. This is very common in practice.
- Hybrid method: for tax purposes some businesses use accrual for purchases and sales of goods and cash for everything else, as long as income is clearly reflected.
If your books are a mix of methods by accident rather than by design, a bookkeeping cleanup can sort it out before tax time.
Which method is right for your business?
Cash basis usually fits if
- You sell services and get paid within a few weeks
- You are a sole proprietor, freelancer or new LLC
- You want the simplest books and taxes on money actually received
Accrual basis usually fits if
- You carry significant inventory or long projects that span months
- You bill on terms and often wait 30 days or more to get paid
- A bank, investor, buyer or government contract asks for GAAP financial statements
- You want to compare true profit month to month
Government contractors, for example, usually need accrual books to support billing and audits. See how we help government contractors and consulting firms.
How to change accounting methods
- Decide whether the change is for your books, your taxes or both. Changing how you view reports needs no IRS approval.
- For taxes, file Form 3115. Many small business changes qualify for automatic consent with no IRS user fee. It is generally attached to your return for the year of the change, with a copy sent to the IRS.
- Calculate the catch up adjustment. Income or expenses that would otherwise be counted twice or missed are adjusted. An adjustment that increases income is usually spread over four years.
- Set up your books correctly. Enter open invoices and unpaid bills so receivables and payables start out accurate.
Before switching, it helps to know who handles what. Read bookkeeper vs accountant to see where each fits.
Seeing both views in QuickBooks Online
QuickBooks Online can show most reports either way. You set a default in Account and settings under Advanced, and you can switch the accounting method on the profit and loss or balance sheet with one click.
- Enter invoices and bills, not just deposits and payments. Without them, the accrual view has nothing to show.
- Apply payments to the invoice or bill they pay. Unapplied payments distort both views.
- Review the A/R and A/P aging reports during your month end close so old balances do not pile up.
Cash vs accrual FAQs
Which accounting method do most small businesses use?
Most small businesses use the cash method for taxes because it is simpler and matches the bank account. Many also look at accrual reports to manage the business.
Can I use cash for taxes and accrual for my books?
Yes. This is common. Your tax return follows one method consistently, while your internal reports can be run on either basis, especially in QuickBooks Online.
What is the gross receipts test for the cash method in 2026?
For tax years beginning in 2026, a business generally passes if its average annual gross receipts for the prior three tax years are $32 million or less. The figure is adjusted for inflation each year.
Is the cash method allowed under GAAP?
No. Generally accepted accounting principles (GAAP) require accrual accounting. Banks, investors and buyers who ask for GAAP statements expect accrual numbers.
Does QuickBooks Online use cash or accrual?
Both. You set a default for summary reports in your account settings, and you can switch most reports, like the profit and loss and balance sheet, between cash and accrual with one click.
How do I know which accounting method my business uses?
Check last year’s tax return. A sole proprietor’s method is checked on Schedule C, line F. Partnerships and S corps also mark their method on their business return.
Can I switch from cash to accrual accounting?
Yes, but for taxes you generally file Form 3115 to change methods. Many small business changes qualify for automatic IRS consent with no user fee, but the timing and catch up adjustment should be planned.
What is modified cash basis accounting?
It is a mix. You keep most records on a cash basis but treat a few items, such as equipment, loans and payroll taxes owed, like accrual. It is common for small firms and nonprofits.
Can a business with inventory use the cash method?
Usually yes, if it meets the gross receipts test. Inventory is still not deducted the day you buy it; small businesses generally deduct it when it is sold or used, or follow how their books treat it.
Not sure which method you use?
We can review your books and returns, confirm your method and set up QuickBooks reports that fit how you run your business. Learn about our accounting and bookkeeping, QuickBooks ProAdvisor and tax planning services.
This article is general information and not tax advice for your situation. Tax rules change, so talk with a qualified professional before making decisions.
