Cash vs accrual accounting comes down to timing. Cash basis records income when the money arrives and expenses when you pay them. Accrual records income when you earn it and expenses when you incur them, whether or not cash has moved. Cash is simpler and matches the bank. Accrual shows the true month. Many small businesses keep accrual books for management and file taxes on cash, which is a decision for your CPA.
This guide is for owners deciding how to set up or run their books in QuickBooks Online or Xero. It is also for anyone whose CPA has asked “which basis are your books on?” and did not know. It explains what each method shows, where each one misleads, how the choice changes the reports, and what to keep consistent. The tax basis you file on is an income tax question. Books LA does not advise on it. Instead, we keep books that can produce either view cleanly and hand them to your CPA.
Cash vs accrual accounting, side by side
| Cash basis | Accrual basis | |
|---|---|---|
| Income lands | When the payment arrives | When you issue the invoice or deliver the work |
| Expenses land | When you pay the bill | When the bill arrives or you incur the cost |
| Accounts receivable and payable | Not on the balance sheet | On the balance sheet |
| Matches the bank statement | Closely | No; profit and cash diverge |
| Shows the true month | No; a slow-paying client moves revenue into next month | Yes |
| Simplicity | Simpler | Needs invoices, bills, and month-end checks |
| Typical use | Tax filing for many small businesses; very small operations | Management reports; businesses with inventory, contracts, or investors |
The IRS describes both methods in Publication 538. Under the cash method, in its words, “you generally report income in the tax year you receive it.” Under the accrual method, “you generally report income in the tax year you earn it, regardless of when payment is received.” Which method a business may use for its return depends on its size and whether it holds inventory. The publication sets a gross receipts test for the small business exceptions. That part is your CPA’s call.
Cash vs accrual accounting: what each shows, and hides
Cash basis is honest about one thing: the bank. If the profit and loss says you made $8,000 in September on cash basis, roughly that much more cash came in than went out. What it hides is timing. A client who pays 45 days late moves September’s revenue into November. So September looks weak and November looks great, and neither is true. A quarterly insurance premium paid in October makes October look terrible. On cash basis, margins jump around for reasons that have nothing to do with the business.
Accrual basis is honest about the month. Revenue sits in the month you did the work, expenses in the month they belong to, and gross margin stays comparable from month to month. What it hides is cash. A profitable accrual month with $30,000 in unpaid invoices can leave the account empty. That is why the balance sheet and the AR aging matter more on accrual books. Our post on monthly financial reports covers the pairing.
How the choice changes the reports
Both QuickBooks Online and Xero can show the profit and loss on either basis with one toggle, as long as you keep the books on accrual. The reverse is not true. Books on pure cash basis, with no invoices or bills entered, cannot produce an accrual view later, because nobody recorded the information. That asymmetry is the practical reason we keep client books on accrual. It preserves the option. The cash-basis report is then one click away for the CPA, the sales tax return, or a quick look at what actually cleared.
Two things must stay consistent whichever view you read. First, the basis stated on the report header, every month, so nobody compares a cash June to an accrual July. Second, the sales tax basis, which the CDTFA sets at registration and which should match how the sales tax return is prepared.
Signs you have outgrown cash basis
- You invoice and wait. If clients pay 30 to 60 days after the work, cash basis reports describe your collections, not your business.
- You carry inventory. Purchases and sales fall in different months, and the margin is meaningless until you match them. Publication 538 also addresses when inventory requires an accrual method; ask your CPA where you land.
- You bill ahead. Retainers, deposits, and annual subscriptions are liabilities until you earn them. Cash basis books them as income the day they arrive.
- Someone outside is reading. Lenders and investors expect accrual reports; our due diligence guide explains why.
- Payroll is a large share of costs. Wages for the last week of the month, paid on the 5th, belong to the month of the work. Accrual puts them there.
Switching, and what not to do
Changing how you keep the books is a bookkeeping project. Enter the open invoices and bills, set the AR and AP balances as of the switch date, and reconcile. Changing the method on the tax return is a different thing. Publication 538 notes that it generally needs IRS approval, by filing Form 3115. Do not change the tax basis on your own because the report looked better the other way, and do not mix bases inside a year. Both are the kind of thing that turns a CPA handoff into a reconstruction.
How Books LA handles this
We keep client books on accrual, with the basis stated on every report. We produce the cash-basis view whenever the CPA, a lender, or the sales tax return needs it. The tax basis on the return stays with the CPA. We make sure the books can support whichever one they choose. Our Los Angeles bookkeeping services guide describes the rest of the monthly service.
Frequently asked questions
Which is better for a small business, cash or accrual accounting?
Accrual for the books, because it shows the true month and can produce a cash view on demand. Which basis to file taxes on is a separate question. It depends on size, inventory, and entity type, and it belongs with your CPA. Many small businesses keep accrual books and file on cash.
Can I keep my books on cash basis and switch later?
You can, but nobody can rebuild the accrual view for the months before the switch, because the invoices and bills never went in. Keeping the books on accrual from the start preserves both views. Switching the tax method is a separate step that generally needs IRS approval.
Why does my accrual profit and loss show profit when the bank is empty?
Because accrual records revenue when you earn it, not when the client pays. The gap is in accounts receivable, owner draws, and loan principal, all of which live on the balance sheet. Read the AR aging next to the profit and loss and the picture closes.
Does QuickBooks Online do cash or accrual?
Both. Reports have a cash or accrual toggle, and the company setting chooses the default. The toggle only works if the books contain invoices and bills. A file where everything goes in as it clears the bank shows the same numbers either way.
Which basis is my sales tax return on?
The CDTFA assigns the basis at registration, and the return should follow that basis consistently. In QuickBooks Online and Xero the sales tax report runs on either. Match it to your CDTFA account and keep it the same every period.
What is the gross receipts test?
A size test in the tax code that decides which businesses may use the cash method and skip inventory accounting for tax purposes. Publication 538 describes it with an inflation-indexed dollar threshold. Whether you meet it, and what it means for your return, is a question for your CPA.
Can I use one basis for management and another for taxes?
Yes, and it is common. Accrual books for running the business, a cash-basis view for the return if your CPA files that way. The requirement is consistency within each use and a clear label on every report. Then nobody compares one basis to the other by accident.
If you are not sure which basis your books are on, book a short call and we will look at the file together.
This post is general information with figures cited from IRS Publication 538. The accounting method used on a tax return is an income tax decision; Books LA does not advise on income tax and works with each client’s CPA on the choice.
