When setting up your books, one of the first and most important decisions you’ll face is whether to use cash basis or accrual basis accounting. Each method has its advantages and drawbacks, and the choice can directly impact how you manage your income, expenses, and overall financial strategy.

So, how do you decide which one fits your business best?

Let’s walk through both options to help you make an informed decision.

What Is Cash Basis Accounting?

To begin with, cash basis accounting is the simpler of the two. You record income only when you receive payment, and you record expenses only when you actually pay them. As a result, this method mirrors your bank account and gives a real-time snapshot of cash on hand.

Example:
If you send an invoice in June and the client pays in July, you record the income in July, not June.

Advantages:

• First and foremost, it’s simple and easy to manage.
• It provides a clear view of your actual cash flow.
• For that reason, it’s a popular choice among small service-based businesses and sole proprietors.

Disadvantages:

• However, it doesn’t align income and expenses with the time they occurred.
• Therefore, it can give you a misleading view of profitability during certain months.

What Is Accrual Basis Accounting?

On the other hand, accrual accounting records income when it’s earned and expenses when they’re incurred, regardless of when the money changes hands. This method focuses on when the work is done—not when the payment happens.

Example:
If you invoice a client in June but get paid in July, you still record the income in June.

Advantages:

• Most importantly, it provides a more accurate picture of your business’s financial health.
• It aligns income and expenses with the correct period, offering better long-term insight.
• As a result, it’s often preferred by larger businesses, especially those with inventory or complex operations.

Disadvantages:

• Nevertheless, it requires more effort to maintain.
• Additionally, it may not reflect your current cash position as clearly as the cash method.

How to Choose the Right Method

So, which method should you use?

• Cash Basis is often ideal for:
  • Contractors, freelancers, and service providers
  • Businesses without inventory
  • Owners who prefer a simple, cash-focused view
• Accrual Basis might be better if:
  • You carry inventory
  • You apply for loans or seek investors
  • You want to match income and expenses to the period they happen

Moreover, it’s worth noting that the IRS may require accrual accounting for certain businesses—particularly those exceeding $25 million in annual revenue or selling products.

💡 Pro Tip from a Bookkeeper:

Choosing the right method from the start helps avoid complications down the line. While you can switch methods later, doing so requires planning, and in some cases, IRS approval.

If you’re unsure which approach suits your business, I’d be happy to help. I’ll guide you based on your goals, business structure, and industry.

📩 Let’s talk about getting your books set up the right way—from day one.

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