Cash accounting records income when it is received and expenses when they are paid; accrual accounting generally records income when it is earned and expenses when they are incurred. That timing difference can put the same sale or bill in different reporting periods. It also means accounting profit and the cash in a business’s bank account may not match.
For U.S. businesses, these are general descriptions, not a universal choice: tax rules, inventory, entity type, and rules for changing methods can affect what a business may use.
How cash and accrual accounting differ
The Internal Revenue Service defines an accounting method as “a set of rules to determine when and how income and expenses are reported.” The key distinction is when transactions appear in the books—not whether the business ultimately receives or pays the money.
| Question | Cash method | Accrual method |
|---|---|---|
| When is income generally reported? | When received, including when it is constructively received under tax rules. | When earned, subject to applicable tax rules. |
| When are expenses generally reported? | When paid, subject to limits such as rules for advance payments and capitalized costs. | When incurred; some costs may need to be capitalized rather than deducted immediately. |
| What does the timing show? | Cash received and paid during the period. | Economic activity associated with the period, even if payment comes later. |
| What does bookkeeping typically involve? | Often simpler to keep. The IRS says many sole proprietors without inventory use it because they find recordkeeping easier. | Tracking items such as income earned but not yet collected and expenses incurred but not yet paid. |
The IRS explains these methods in Publication 583, Starting a Business and Keeping Records (December 2024), and Publication 334, Tax Guide for Small Business (2025). HRSA’s Payment Management System defines cash-basis expense timing as recording expenses when paid in its FAQ, last reviewed July 2022.
How the timing works for an invoice and a bill
Work completed in December, paid in January
Suppose a service business completes work in December and receives payment in January. Assuming the income was earned in December and was not constructively received earlier, an accrual-method explanation generally puts the income in December, when it was earned. A cash-method explanation generally puts it in January, when the payment is received.
An expense incurred before it is paid
If a business incurs an expense in December and pays it in January, a cash-method taxpayer generally reports the expense when paid. An accrual-method taxpayer generally accounts for it when incurred, though the tax treatment may require capitalization or otherwise affect when it can be deducted. These are general timing explanations; tax rules can change the result.
What each method can tell you about a business
Cash-basis records make it easier to see the timing of money coming in and going out. But a period with substantial collections can look strong even if some of that cash relates to earlier work, while a period with large payments can look weak even if some bills relate to other periods.
Accrual records aim to associate income and expenses with the periods they relate to. That can make a period’s reported results more informative about its activity, but it requires tracking unpaid invoices, outstanding bills, and other timing differences. Neither method, by itself, shows the full cash position: a business using accrual accounting still needs to monitor cash flow.
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How inventory and U.S. tax rules affect the choice
In U.S. federal tax guidance, the method that is easiest to maintain is not automatically available to every business. The IRS generally requires accrual accounting for purchases and sales when inventory is necessary to account for income, while also describing an exception for qualifying small-business taxpayers. It is therefore too broad to say that every business selling goods must use accrual accounting. Entity type and other statutory restrictions can matter as well.
The IRS says a business generally chooses its accounting method when it files its first business income tax return and must use a method that clearly shows income. After adopting a method, changing it generally requires IRS approval, although automatic-change procedures are available for some changes. Check current IRS publications and instructions before adopting or changing a method. See Publication 583, Publication 334, and Publication 538, Accounting Periods and Methods.
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This discussion concerns general accounting concepts and U.S. federal tax guidance. It does not establish what is required for a particular state, country, industry, lender, investor, or contract, and it is not individualized tax advice.
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