When it comes to cash or accrual accounting, you're not just picking a bookkeeping method—you're making a choice that affects your taxes, growth potential, and day-to-day operations.
Whether you're running a nonprofit, agency, or small business, getting this wrong could mean compliance headaches, missed financing opportunities, or unnecessary tax complications. Get it right, and you'll have a financial foundation that actually supports your goals.
At Hiline, we believe switching accounting methods isn't just about compliance—it's a strategic business decision that should align with your company's growth trajectory and future goals. Most firms only address this when clients hit revenue thresholds, but we help you think proactively about three key factors: mandatory requirements, tax optimization, and business strategy.
In this guide, we'll break down the real differences between these two methods, clarify the current IRS rules, and help you figure out which one makes sense for where your business is heading.
By the end, you'll know exactly which accounting approach fits your situation—and when it might be time to switch.
What is cash-based accounting?
Cash-based accounting records financial revenue when you receive the payment and expenses when you pay them out.
For example, let’s say you:
- Invoice a service for $1000 due at the end of the month
- Paid $200 in utility bills you received two weeks ago
- Receive another $1,500 from a customer that you invoiced at the start of the month.
You would record $1,500 of revenue and $200 of expenses using the cash method. That’s because the client who owes you hasn’t paid yet, and you have paid your utility bills.
If you’re considering using this account method, there are a few things you’ll want to keep in mind.
The pros of cash-based accounting
There are two main reasons businesses opt for cash-based accounting.
- Easy to follow — Cash accounting is often considered the easiest accounting method, especially by small businesses, since you track your finances similarly to how you would your own personal accounts.
- Tax purposes — Since you don't record revenue until you receive it, that sometimes works in your favor during tax season. You can't pay taxes on money you don't have yet.
But there are a few downsides to consider.
The cons of cash-based accounting
As your business grows, cash-based accounting might cause some problems since this method is:
- Not GAAP compliant — Cash-based accounting doesn’t follow GAAP guidelines, meaning you may have to switch methods as you grow to be compliant.
- Lacks an AR or AP — Since you track revenue and expenses when you receive the money, there’s no need for accounts receivable or accounts payable under this method. As a result, you lack those records and the ability to use them to improve financial visibility.
- Paint a foggy financial picture — Although this method can make your business seem more profitable on paper, it doesn't give you the most accurate view of your finances, which can hurt in the long run.
What is accrual accounting?
Accrual accounting records revenue and expenses when they are earned or invoiced. Once you send out an invoice, you count that amount toward your revenue. Similarly, once you receive a bill, even if you don’t immediately pay it, you record it in your overall expenses.
If we revisit our example above, with the accrual method, you would record $2,500 of revenue and $200 of expenses. The $1,000 you were waiting to account for under the cash method is now counted toward your overall revenue.
Just like the cash method, accrual accounting has its benefits and drawbacks.
The pros of accrual accounting
Accrual accounting works in your business's favor by:
- Conforming to GAAP — When you follow these standards from day one, you won't have to worry about compliance or any issues with meeting lenders’ requirements as you grow.
- Allowing for scalability — Since this method works for businesses of all sizes, you can follow it from your startup days to IPO.
- Painting a clear financial picture — Because you have accounts payable and accounts receivable under this method, you have detailed records of every transaction that more accurately show your financial situation.
The cons of accrual accounting
The complexity of accrual accounting can be tricky to manage, especially for small businesses. This is because this method:
- Requires more time and effort — Tracking financial transactions under this method can be labor-intensive and time-consuming, especially for businesses with minimal resources.
- Doesn’t track cash flow — Due to how revenue and expenses are recorded under this method, you might have a less accurate idea of your cash flow. You'll have to track that separately through cash flow forecast using tools such as Hiline’s 13-week cash flow.
- Lacks short-term accuracy — Accrual accounting won't tell you your final revenue and expense amounts until you close your books at the end of the month, making it better for long-term visibility but not great for short-term.
Which accounting method should I choose?
The accounting method you choose depends on your current operations and future goals. We’ll explore each piece in more detail below, but first, here's a quick comparison to help you decide:
The Hiline Framework: Three Strategic Reasons to Consider Your Accounting Method
Rather than waiting until you're forced to make a change, we recommend evaluating your accounting method through these three lenses:
1. Mandatory IRS Requirements
Some businesses must use accrual accounting, regardless of preference:
- Revenue threshold of $31 million for 2025 (this number updates annually for inflation)
Exception: Certain business types can use cash accounting even above the revenue threshold, including S corporations, partnerships without C corporation partners, farming businesses, and specific personal service corporations.
- Inventory-based businesses (with limited small business exceptions)
- Nonprofits requiring GAAP compliance for audits and grant requirements
2. Tax Planning Optimization
Your accounting method directly impacts your tax strategy. You’ll want to consider:
- Maximizing partner/owner basis for distributions
- Controlled timing of revenue and expense recognition
- A strategic dual-method approach – Some companies maintain accrual books but file cash-basis tax returns (more on this below!)
- Optimal current tax position while maintaining future flexibility
This is where working with a strategic accounting partner becomes crucial. The right approach can save significant tax dollars.
3. Forward-Looking Business Strategy
Think about where your business will be in 2-3 years, not just today:
- Funding & Investment – Investors expect GAAP-compliant (accrual) financials
- Growth Trajectory – Fast-growing companies benefit from accrual's scalability and accuracy
- Exit Planning – M&A requires audited, accrual-based financials
- Revenue Models – SaaS and contract-based businesses need proper revenue recognition
Cash Method Still Makes Sense When:
- You're a smaller, stable business with simple transactions
- Tax planning and cash flow control are top priorities
- You're not seeking external funding or planning for audits
Accounting Method FAQ
Which accounting method is better for small businesses?
It depends on your situation. Cash accounting is simpler and offers better short-term cash flow visibility. Accrual accounting provides a more complete financial picture and is required if you have inventory, seek investors, or plan significant growth.
Can I switch from cash to accrual accounting?
Yes, you can start with cash accounting and switch to accrual later—but it's not simple. Changing methods requires IRS approval using Form 3115 and careful timing. Before making the switch, consult your accountant to avoid costly mistakes and ensure proper compliance.
What happens if I choose the wrong accounting method?
Choosing the wrong method can lead to compliance issues, tax complications, or missed opportunities for financing. However, you can change methods with proper IRS approval and professional guidance. Additionally, once you switch accounting methods, you're locked in for 5 years. The IRS requires long-term business reasons, not short-term tax benefits.
Do I need to use the same accounting method for taxes and financial statements?
Not necessarily. You can use different methods for tax reporting versus financial statements, though this requires maintaining separate records and can add complexity.
Additional Considerations
Even if you qualify for cash accounting, you may still benefit from accrual if you're planning to scale, need financing, or want more detailed financial insights for decision-making. Here are a few more factors that might tip the scale:
1. Business complexity
How big is your business? How many invoices and payments do you handle every month? Cash accounting might work for small businesses with simpler finances, but larger organizations have more robust finances that require accrual accounting methods.
2. Industry-specific needs
Certain industries benefit more from accrual accounting regardless of size:
- SaaS companies with multi-month contracts need proper revenue recognition
- Agencies with project-based work benefit from matching revenue and expenses
- Nonprofits often require GAAP compliance for grants and donor requirements
3. The dual-method advantage
For some businesses, the best approach is to maintain accrual books while filing cash-basis tax returns. This strategy provides comprehensive financial reporting for management and stakeholders while preserving tax timing advantages. However, this requires maintaining essentially two sets of records and adds complexity to your accounting process.
The best of both worlds with real-time accounting for small business
Maybe you're outgrowing cash-based accounting but aren't ready for the complexity of full accrual. Or perhaps you like accrual's comprehensive view but miss having instant cash flow insights.
But you don't have to choose between simplicity and accuracy.
With Hiline's real-time accounting powered by Digits, you get the financial clarity of accrual accounting with the immediate insights of cash-based tracking. That means real-time bookkeeping, one-click transaction details, instant cash flow visibility, and comprehensive financial support—all automated and accessible whenever you need it.
No more waiting until month-end to understand your financial position. No more choosing between what's easy and what's accurate.
Ready to see how real-time accounting can work for your business? The right accounting method positions your business for success across compliance, tax efficiency, and growth—the wrong one creates unnecessary complexity and missed opportunities.
That's why we help you make this decision strategically, not reactively, analyzing your compliance requirements, tax optimization opportunities, and strategic objectives before you're forced into a choice.
Schedule a free consultation to discuss your specific needs and discover how we can streamline your accounting with a forward-thinking approach that grows with your business.
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