Before your books can answer any question, they have to answer this one: when does a sale count? When you do the work, or when the money arrives? That single choice — cash basis versus accrual basis — changes what every report says. The same month can look profitable under one method and break-even under the other, with nothing different about the business itself.
Cash basis: count it when the money moves
Under cash-basis accounting, revenue is recorded when the payment lands and expenses are recorded when you pay them. It's intuitive — the books roughly track the bank account — and it's simple to maintain. For very small service businesses with no inventory, no invoicing terms, and no lenders to satisfy, cash basis is often perfectly adequate.
Its weakness is timing distortion. Land three customer payments in one week and the month looks spectacular; pay your annual insurance premium the next month and it looks terrible. Neither picture reflects how the business is actually performing.
Accrual basis: count it when it's earned
Under accrual accounting, revenue is recorded when you earn it — work delivered, product shipped — and expenses are recorded when you incur them, regardless of when cash moves. The point is matching: each month's revenue sits next to the costs that produced it, so margins mean something and months are comparable.
Accrual is the method lenders, investors, and buyers expect, and it's effectively mandatory once inventory is involved — buying $50,000 of stock isn't an "expense" the day you buy it; it becomes cost of goods sold as it sells. Larger businesses are required by the IRS to use accrual, but most small businesses get to choose.
The same month, two stories
Say a design firm finishes a $30,000 project in June, invoices it on net-30 terms, and pays $18,000 in June wages for the work. On an accrual P&L, June shows $30,000 of revenue against $18,000 of cost — a $12,000 profit, which is the truth of what June accomplished. On a cash P&L, June shows $0 of revenue and $18,000 of expenses — an $18,000 loss — and July shows a $30,000 windfall. Same firm, same work, opposite stories. Multiply that across a year of projects and the cash-basis books become nearly impossible to manage from.
How to choose
- You invoice customers on terms → accrual. The gap between earning and collecting is exactly what cash basis can't see.
- You carry inventory → accrual, almost without exception.
- You want a loan, investors, or an eventual sale → accrual. It's the language those audiences speak.
- You're a small service business paid at time of service → cash basis may be all you need, at least for now.
One wrinkle worth knowing: your books and your tax return don't have to use the same method. Plenty of businesses run accrual books for management and let their CPA file on a cash basis when that's tax-advantageous. What kills you is inconsistency — flipping methods month to month, or books that are accidentally half-and-half, make every report unreliable. And remember that even accrual profit isn't cash in the bank — that's its own topic, covered in Profit vs. Cash Flow.
When you outsource bookkeeping with InsightTrack, we set your books up on the method that fits your business, keep it consistent every single month, and coordinate directly with your CPA — including when your tax return is filed on a different basis than your books. You get reports that mean the same thing every month, which is the whole point. Schedule a free consultation and we'll tell you which method your business should be on.