Every business has to decide when to record a sale or an expense. That choice is your accounting method, and it changes what your reports show and, sometimes, how much tax you pay in a given year.
Cash method
You record income when the money arrives and expenses when you pay them. If you send an invoice in December and the client pays in January, that sale counts in January.
- Pros: simple, matches your bank account and lets you time some income and expenses at year-end.
- Cons: it can hide what you really earned in a month if clients pay late or you prepay bills.
Accrual method
You record income when you earn it (when you send the invoice) and expenses when you owe them, even if no money has moved yet.
- Pros: shows the real profit of each month and what clients owe you and what you owe.
- Cons: more work, and you can owe tax on sales you haven't collected yet.
Which one can you use?
Most small businesses can choose the cash method for taxes. Larger businesses (with average yearly sales above a limit set by the IRS that is adjusted for inflation) and some businesses with inventory have stricter rules. Once you pick a method on your first return, changing it later usually requires IRS approval.
A practical answer
Many small businesses file taxes on the cash method and also look at accrual reports in QuickBooks to manage the business. Your bookkeeper can show you both views from the same books.
Questions to ask yourself
- Do clients usually pay you right away, or 30 to 60 days later?
- Do you sell products and keep inventory?
- Do you plan to apply for a loan or bring in investors (who usually want accrual reports)?