Cash and accrual accounting differ in when you record income and expenses. Cash basis records transactions when money actually changes hands. Accrual basis records them when the work is done or the bill is received, regardless of when payment happens.

For most small businesses, cash basis accounting works fine and is simpler to manage. You record income when customers pay you and expenses when you pay vendors. Your books reflect what’s actually in your bank account, which makes cash flow easier to understand at a glance.

Accrual accounting gives you a more accurate picture of profitability over time but requires more tracking. If you send a $5,000 invoice in December but don’t get paid until January, cash basis shows that income in January. Accrual shows it in December when you earned it. For businesses with significant accounts receivable, accrual provides better insight into how the business is actually performing month to month.

The IRS allows businesses with less than $29 million in average annual gross receipts to use cash basis. Above that threshold, accrual is required. Some businesses must use accrual regardless of size, particularly those with significant inventory or those structured as C corporations. Medical and dental practices often use cash basis successfully because most revenue comes from insurance payments and patient collections without significant inventory concerns.

Cash basis works well for service businesses that get paid quickly, businesses with straightforward transactions, and owners who want maximum control over tax timing. If you want to reduce taxable income at year end, you can delay sending invoices or prepay certain expenses. That flexibility disappears with accrual accounting because income is recognized when earned regardless of payment.

Accrual makes more sense if you carry inventory, have significant receivables, plan to seek financing or investors, or want a clearer picture of true profitability by period. Banks and investors often prefer accrual-based financials because they show what the business has earned and owes rather than just what moved through the bank account.

Once you choose a method, switching requires IRS approval through Form 3115. Getting the decision right from the start avoids that hassle later. For most small businesses starting out, cash basis is the simpler and more practical choice. If you’re unsure which method fits your situation, working with experienced Macomb, MI bookkeepers helps you set things up correctly from day one so your records are useful for both daily decisions and tax time.