Should My Small Business Use Cash or Accrual Accounting?

By Bill Stilwell · Last reviewed October 17, 2026

The short answer

Your accounting method is the set of rules for when you count income and expenses. With the cash method, you count income when you receive it and expenses when you pay them. With the accrual method, you count income when you earn it and expenses when you owe them. Most small service businesses can use cash, but some businesses must use accrual, so choose with a CPA before your first return, because changing later generally needs Internal Revenue Service (IRS) approval.

What this means

IRS Publication 538 describes the main methods:

Cash method. Report income in the year you receive it. Deduct expenses in the year you pay them. Most individuals and many small businesses use it.
Accrual method. Report income in the year you earn it, even if you haven’t been paid. Deduct expenses in the year you owe them, generally once the work or goods are delivered.
Hybrid method. A mix of the two, allowed if it clearly reflects income and you use it the same way every year. The IRS sets limits, for example on mixing methods for inventory.

Who can’t use cash? The IRS says C corporations, partnerships with a C corporation partner, and tax shelters generally can’t, unless they meet a gross receipts test. That test looks at average yearly gross receipts over the prior 3 years. The IRS set the limit at $26 million and adjusts it for inflation each year, so check the current figure with your CPA. Tax shelters can’t use the cash method at all.

Inventory: Publication 538 says small businesses that meet the gross receipts test can choose simpler ways to handle inventory instead of keeping formal inventory accounts. Ask your CPA which applies.

Made-up example: Blue Ridge Landscaping finishes a $4,000 job on December 20 and gets paid January 10. Using cash, that income counts in January’s year. Using accrual, it counts in December’s year, when the work was done.

Why it matters

It changes when you pay tax. The same job can land in different tax years.
It changes what your reports show. Accrual shows what you’ve earned and owe. Cash shows what’s in the bank.
Your books and return must match. The method you use on your return should be the one in your software.
It’s hard to change. The IRS generally requires Form 3115 to change methods.

Who this applies to

Every business. Most small service businesses, like cleaners, consultants, and contractors, start on cash. Product businesses with inventory, growing companies, and C corporations should get advice first. Many states follow the federal method, but check with your state tax department.

How to do it

List how you get paid. Upfront, at the end of a job, or on invoices with terms (see 10.7.5 Invoices).
Note if you carry inventory or sell products.
Check your entity type. C corporations and some partnerships face limits.
Meet with a CPA and pick a method before your first return.
Set the method in your accounting software so reports match your return (see 10.5.1 Chart of Accounts).
File your first return using that method. You’ll mark it on the return.
Keep using it the same way every year.
Watch for triggers to revisit, like crossing the gross receipts limit or adding inventory. Changing generally means filing Form 3115.
Record the method in your Master Business Record.

Even on the cash method for taxes, many owners also track unpaid invoices and unpaid bills so they know what’s coming (see 10.5.6 Accounts Receivable and 10.5.7 Accounts Payable).

What proof to keep

Your first return showing the method
Your software’s method setting
Your CPA’s written recommendation
Any Form 3115 and IRS response

Common mistakes

Software on accrual, return on cash. Your reports and taxes won’t match.
Switching methods without approval.
Ignoring unpaid invoices on cash. Cash books can look worse or better than reality.
Skipping advice on inventory. Product businesses have extra rules.
Assuming a C corporation can use cash. Check the gross receipts test.

When to get help from a pro

CPA or enrolled agent: before your first return and before any change. Questions to ask:

Which method fits how I get paid and what I sell?
Do I meet the gross receipts test, and how do I handle inventory?
Should my management reports use a different view than my tax return?

Bill’s note

[Bill: add a short note. For example, which method SiteSmarty uses and why, or how a client’s cash books hid a pile of unpaid invoices.]

How I did this for SiteSmarty

[Date I did this:]
[What I actually did, step by step: which method SiteSmarty uses and where I set it]
[What it cost and how long it took:]
[What surprised me or what I’d do differently:]
[Screenshot or photo to add, with private info blurred: the accounting method setting in the software]
[Result so far:]

Questions people ask

What’s the difference between cash and accrual? Cash counts income and expenses when money moves. Accrual counts them when income is earned and expenses are owed.

Can my small business use the cash method? Most can. C corporations and partnerships with a C corporation partner must meet a gross receipts test, and tax shelters can’t use it.

What is the hybrid method? A mix of cash and accrual. The IRS allows it if it clearly reflects income and you use it consistently, with limits on inventory.

How do I change methods? Generally by filing Form 3115 and getting IRS approval. Ask your CPA first.

Do I have to track inventory? It depends. Small businesses that meet the gross receipts test can use simpler options. Ask your CPA.

Audit check

Question: Does the business use one accounting method, chosen with professional advice, the same way in its books and its returns?
Pass looks like: Method recorded. Software and returns match. Any change filed on Form 3115. Unpaid invoices and bills tracked.
Fail looks like: Owner unsure of the method. Software and return don’t match. Method changed without approval.
Evidence to collect: First return, software settings screenshot, CPA recommendation, and any Form 3115.

Where this fits

Do this first: 10.1.3 Tax Year

Do this next: 10.1.5 Estimated Taxes

Sources

IRS, Publication 538, "Accounting Periods and Methods" (checked October 17, 2026)
IRS, Publication 583, "Starting a Business and Keeping Records" (checked October 17, 2026)

This page explains general rules and Bill's own experience. It is not legal, tax, or insurance advice. Talk to a qualified professional about your situation.