Cash vs accrual accounting: which should your business use?

Cash and accrual are the two ways to keep your books, and the choice changes what your financial statements tell you, when you owe tax, and how clearly you can see whether the business is actually profitable. Here is the difference in plain language, and how to decide.

Cash-basis accounting

You record revenue when the payment lands and expenses when you pay them. Simple, and it mirrors your bank balance closely.

• Pros: easy to maintain, shows real cash on hand, and you are not taxed on income you have invoiced but not yet collected.
• Cons: it can hide the true picture — a great month where you paid all your bills looks worse than a weak month where you paid nothing, because timing distorts the numbers.

Accrual-basis accounting

You record revenue when you earn it (send the invoice) and expenses when you incur them (receive the bill), even if the cash moves weeks later. This uses accounts receivable and accounts payable to bridge the timing gap.

• Pros: matches revenue to the costs that produced it, so profit-and-loss statements reflect real performance. It is the standard for lenders, investors and most growing businesses.
• Cons: more work, and your books can show a profit while your bank account is tight, because income recorded is not always cash collected.

A quick example

You finish a $5,000 project in March and get paid in April.

• Cash basis: $0 revenue in March, $5,000 in April — even though the work happened in March.
• Accrual basis: $5,000 revenue in March (when earned), with the April payment simply clearing the receivable.

Accrual tells you March was a strong month; cash basis makes March look empty and April look inflated.

Which should you choose?

• Cash basis fits many small service businesses, sole proprietors and freelancers who want simplicity and whose income and expenses land close together.
• Accrual basis fits businesses that carry inventory, invoice on terms, are seeking financing, or simply want an accurate month-to-month read on profitability.
• Canadian tax note: the CRA generally requires business income to be reported on the accrual basis (self-employed farming and fishing are notable exceptions). Many businesses keep day-to-day cash-style records and convert to accrual at year-end — a conversation worth having with your accountant.

Official references

• Canada Revenue Agency: Accrual method of reporting income
• Canada Revenue Agency: Keeping records

This guide is general educational information, not accounting or tax advice.

Frequently asked questions

What is the difference between cash and accrual accounting?

Cash accounting records revenue and expenses when money actually moves. Accrual accounting records them when income is earned or an expense is incurred, regardless of when the cash arrives, using accounts receivable and payable to bridge the timing.

Which is better for a small business?

Cash basis suits many simple service businesses and freelancers who want simplicity. Accrual basis gives a more accurate picture of profitability and is expected by lenders and investors, so it fits businesses with inventory, invoicing on terms, or growth plans.

Does the CRA require accrual accounting?

Generally yes — the CRA requires most business income to be reported on the accrual basis, with limited exceptions such as self-employed farming and fishing. Many businesses keep cash-style records day to day and convert at year-end with their accountant.