Cash basis vs accrual basis refers to two different ways of recording income and expenses. Cash basis tracks money only when it is paid or received, while accrual basis records income and expenses when transactions occur.
There are two core accounting methods: Cash basis vs Accrual basis. Both influence how a business calculates its profit, handles taxes, and how income and expenses appear on the financial statements.
But not every D2C company gets to decide which method to use! The selection is largely dependent on the IRS (Internal Revenue Service) rules and GAAP (Generally Accepted Accounting Principles) requirements.
For example,
- Businesses crossing $26 million in average annual receipts cannot use the cash basis
and
- Any business that follows GAAP must use accrual accounting.
Thus, as a VP or director of a D2C company, you must understand the difference between cash basis vs accrual basis to make the right selection. Read this article till the end to learn how each system works.
What is Cash Basis of Accounting?
Cash basis accounting is a way of recording your income and expenses only when money moves in or out of your bank account.
- You record income when you receive the payment.
and
- You record expenses when you pay the bill.
You don’t record anything based on invoices sent or bills received. That’s because in this system, only actual cash movement matters.
Okay, so who uses this? This method is common for freelancers, consultants, and D2C businesses that have yearly revenue below $26 million or do not hold inventory. Many VPs or directors of such consumer brands prefer this approach as there are no extra steps like tracking receivables, payables, or making special adjustments.
What is the Accrual Basis of Accounting?
Accrual accounting records income and expenses when they happen (even if no money has moved yet).
- You record income when you finish the work or deliver the product, even if the customer pays later.
and
- You record expenses when you receive the service or goods, even if you pay the bill later.
This method connects the income you earn with the costs that helped you earn it. Several larger businesses use this method because it follows standard accounting rules (GAAP). It is also required if you:
- Have inventory
- Want outside investors or loans
- Cross the IRS limits for using cash basis accounting.
Cash Basis vs Accrual Basis: How Do They Differ?
Both methods track the same money, but they tell very different stories about your business. Cash basis shows what is happening in your bank account. In contrast, accrual shows what is happening in your business.
To further improve your conceptual understanding, check out the difference between cash basis vs accrual basis:
| Category | Cash Basis Accounting | Accrual Accounting |
| When You Record Income | When the payment reaches your bank account. | When you finish the work or deliver the product, even if the client pays later. |
| When You Record Expenses | When you pay the bill. | When you receive the goods or service, even if you pay later. |
| View Of Business | Shows short-term cash movement. | Shows long-term business activity and performance. |
| Profit Accuracy | Profit can look high or low depending on payment timing. | Profit aligns with the actual work done and costs used. |
| Tax Impact | Taxes depend on when money enters or leaves your bank. | Taxes depend on when income and expenses occur. |
| Complexity | Simple to use. No tracking of unpaid invoices or bills. | More detailed. Tracks receivables, payables, and adjustments. |
| GAAP Compliance | Not allowed under GAAP. | Required under GAAP. |
Pros and Cons of Cash Basis Accounting
Cash basis accounting is popular among small businesses due to its ease of use. However, its simplicity comes with limits. For more clarity, let’s see both sides of this accounting system:
Pros
- Simple to Use: You record transactions only when money moves. No tracking of unpaid invoices or unpaid bills.
- Clear View of Cash on Hand: Your financial records match your bank balance. You always know how much money is available to spend.
- Lower Cost of Bookkeeping: Since there are no receivables, payables, or month-end adjustments to track, the workload is lighter. This often means lower accounting costs.
Cons
- Profit Can Look Misleading: Your books may show a high profit in a month only because several clients happened to pay at the same time. It does not always reflect when the work was actually done.
- Not Allowed Under GAAP: If your business needs audited statements or wants lenders or investors to review financials, a cash basis will not meet their reporting standards.
- Not Permitted for Certain Businesses: You cannot use the cash basis if:
- Your business has inventory
and
- Your average yearly revenue is over $26 million (adjusted for inflation).
Pros and Cons of Accrual Accounting
Accrual accounting looks beyond your bank balance! It shows what your business has earned and what it owes (even if there is no cash movement yet). This gives a deeper view of performance, but it also makes the bookkeeping heavier. Again, let’s understand both sides:
Pros
- Shows the Real Performance of the Business: Income and expenses are recorded when the work happens, not when the payment arrives. This helps you see if the business is truly profitable during a particular period (even if some clients pay later).
- Required for Audits, Investors, and Lenders: If your business wants funding, an audit, or must follow GAAP standards, accrual accounting is the accepted method.
- Supports Long-Term Planning: Since everything is recorded as and when the transaction happens, you get a better view of your margins, future income, and upcoming costs.
Cons
- More Work to Maintain: You must track unpaid invoices, unpaid bills, and make adjustments at the end of each period. This adds extra steps and increases the bookkeeping workload.
- Profit Can Look Stronger Than Your Cash Balance: Your financial statements may show a profit even if you have little cash on hand. This happens because clients have not paid yet. This gap can be confusing for business owners who link profit to bank balance.
- More Complex Tax Reporting: Tax filing needs extra adjustments to match income and expenses to the correct time period. This adds another layer of work during tax season.
When to Choose Cash Basis vs. Accrual Basis
Choosing between cash basis vs accrual basis depends on how your business works and what you want to achieve. Remember that the right method depends on your size, complexity, and future plans. To make a better choice, refer to the table below:
| When to Choose Cash Basis | When to Choose Accrual Basis |
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So now you know the difference between cash basis vs accrual basis. Cash basis follows the movement of money in and out of your bank account, while accrual basis records income and expenses when the transaction occurs (even if the payment is delayed).
As a VP or director of a D2C company (earning $5M+ revenue), you may choose a cash basis if your business is small + has no inventory. Whereas, you may choose the accrual basis if you invoice clients, carry inventory, or want to prepare financial statements following GAAP.
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Cash Basis vs Accrual Basis FAQs
1. Which method – cash basis vs accrual basis – gives me a better view of my business?
Cash basis shows the money you have today, but it can hide unpaid bills or income you’ve already earned. Accrual shows what you truly earned and owe. If you want a 100% complete picture of your business performance, the accrual basis gives more clarity. It is widely used for budgeting, business planning, and calculating margins.
2. Can switching methods lower my taxes in 2025?
It depends on timing! Under the cash basis, you are taxed only when the money reaches your bank. So if clients pay you in the next year, the tax also moves to the next year. This can delay your tax bill.
In contrast, under the accrual basis, income is taxed when the work is completed, even if the client hasn’t paid yet. So if you finish a project in December but receive payment in February, the income is still taxed in December.
Remember that switching methods can change when your income is taxed, but not how much you earn.
3. What if my profit looks strong on paper, but my bank balance is low?
This happens under accrual accounting when clients owe you money. The work is recorded as income, but the cash has not arrived. To resolve this gap, you must:
- Track receivables
- Shorten payment terms
- Follow up on overdue invoices
Also, please note that profit and cash are not always the same.
4. Is cash basis still an option if I hold some stock or materials?
If inventory is a major part of your sales, the IRS usually requires accrual accounting. But if inventory is minor or used only for internal purposes, you may still qualify for the cash basis.