.jpeg)
What is accrual accounting?
Accrual accounting is a method of accounting in which revenue is recorded when it’s earned, and expenses are recorded when they are incurred, not when transactions take place. The entries are recorded regardless of when cash actually changes hands. Even when the payment lands weeks later, the accrual basis or accrual method records a sale the moment you deliver work and a cost the moment you take it on.
Accrual accounting is a double-entry method, and it’s the standard under GAAP (Generally Accepted Accounting Principles). Most growing businesses use it for one reason: it shows what's really happening across the business, not just what's hit your bank account.
What are the two core principles behind accrual accounting?
Accrual accounting rests on two core principles:
- The revenue recognition principle
- The matching principle
Together, these two pillars keep your income and expenses tied to the periods they actually belong to, which is what makes your numbers reflect your real performance instead of payment timing.
1. The revenue recognition principle
The revenue recognition principle says you record revenue when you earn it, not when you get paid. For example, you built a custom furniture order and delivered it in August. The moment the order is fulfilled, your books will reflect the work you did that month rather than recording it at the time of payment.
2. The matching principle
The matching principle says you need to record the expenses in the same period as the revenue they helped create. Continuing with the same example, to fulfill the furniture order, you spend around USD $1,800 on materials and labor to complete it in August; those costs belong in August too, right in parallel to the revenue. Match the two, and you get a true read on what that job actually earned you.
What are the key financial items tracked in accrual accounting
Four main metrics are tracked when it comes to accrual-based accounting: accrued revenue, accrued expenses, deferred revenue, and prepaid expenses. Each of these helps in bridging the gap between when value moves and when cash does.
1. Accrued revenue
Accrued revenue is income you've earned but haven't billed or received payment for yet. For example, you complete a consulting project worth USD $500 in October but invoice the client in November. The revenue is still recognized in October because that's when you earned it, even though the payment arrives later.
2. Accrued expenses
Accrued expenses are costs that you have incurred but haven’t paid yet. For example, you received supplies worth USD $200 in October but paid in November. The expenses will still be noted for October and not when you repay.
3. Deferred revenue
Deferred revenue is money you've collected before delivering the work, also called unearned revenue. A client prepays USD $1200 for a year of access, and you recognize USD $100 each month as you deliver the service. Until then, it sits on your books as a liability.
4. Prepaid expenses
Prepaid expenses are payments you make upfront for something you'll use later. You pay USD $1200 for a year of insurance in January, then expense USD $100 a month as you use the coverage.
The pattern is worth noticing. Accruals record the value before the cash. Deferrals and prepaids record cash before the value is recognized. They're mirror images of the same timing problem.
Cash basis vs accrual basis accounting
Cash basis and accrual basis accounting differ on one thing: timing. Cash basis accounting records revenue and expenses only when money actually moves. Accrual basis accounting records them when revenue is earned, or expenses are incurred, regardless of when cash changes hands.
That single difference ripples into how complex your books are, what your statements show, how you're taxed, and whether investors and regulators take your numbers seriously.
[Table:1]
What is the IRS eligibility for cash accounting
Not every business is required to switch to accrual accounting. IRS allows various small businesses to continue using cash accounting until they meet the eligibility requirements. Your business is eligible to use cash accounting if:
- Your business's average annual gross receipts are below the IRS threshold for 2025, which is currently USD $31 million (adjusted annually for inflation); you can choose between the accrual method of accounting and cash accounting.
- If your business exceeds the threshold are generally required to use the accrual method for tax reporting.
- Certain businesses may still qualify for exceptions, including some farming businesses and qualified personal service corporations, depending on their circumstances and IRS rules.
Although the IRS eligibility varies from business to business based on its structure and activities. It is worth reviewing the latest IRS guidelines or consulting a CPA before choosing either of the accounting methods.
Why should you opt for accrual accounting for your business
One of the primary reasons you should choose accrual accounting over cash-based accounting is that it shows you the real-time state of the business. The number isn’t just about the cash that is sitting in the bank today but what you have earned, what you’re owed, and what you owe. This way, you get to make confident decisions, forecast accurately, and raise money. This is why GAAP and most investors treat this as the standard way of accounting. Here’s why you can consider using the accrual method of accounting:
- Accurate profitability tracking: Accrual basis accounting helps you match revenue to the exact costs that earned it. This way, your numbers reflect the real operational performance instead of swinging with the timing of when invoices get paid.
- Better financial forecasting: You can depend on accrual accounting for more than just tracking cash. By tracking accounts receivable and accounts payable, you can estimate future cash inflows from unpaid customer invoices, plan any upcoming supplier payments or operating expenses, identify potential cash shortages as they affect payroll and overall business operations, and build more accurate cash flow budgets and financial forecasts.
- Easier to raise capital: Accrual accounting makes it easier for you to raise money from investors, lenders, and potential buyers, as they rarely evaluate a business based solely on its cash balance. They need to look at financial statements that show sustainable revenue, operating margins, risks taken, outstanding obligations, if any, and consistent financial performance.
- Supports long-term growth and compliance: Cash accounting is well-suited to early-stage startups and businesses because it’s straightforward. As your company grows, you need something that can handle complex workflows such as credit sales, inventory, subscriptions, and long-term contracts. Accrual-based accounting becomes more practical to manage these processes.
- Improves and supports decision-making across the business: Accrual accounting offers founders and stakeholders a clearer understanding of business performance by separating profitability from cash movement. Whether you are deciding to hire, expand into a new market, increase marketing spend, or launch a new product, you can make these big decisions using the financial results that reflect what the business has actually earned and spent.
Founder tip: Accrual accounting tells you whether your business is profitable. Your cash flow statement tells you whether you have enough cash to fund that growth. Reviewing both together gives you the clearest picture of your business's financial health.
What is the downside of using accrual accounting
Accrual-based accounting is best if you want a more accurate view of your business, but some additional responsibilities accompany it. You might find yourself spending more time keeping your books maintained and accurately updated as your business grows. Here are some of the trade-offs of accrual-based accounting to consider.
- Complex accounting technique: The accrual method of accounting is complex because, unlike cash accounting, it requires adjusting entries, revenue recognition rules, and regular bank reconciliations.
- Time-consuming process: Because you're tracking Accounts Receivable, Accounts Payable, and other accruals, month-end closes typically take longer. Keeping your records accurate also requires regular reviews and reconciliations to ensure transactions are recorded in the correct period.
- Higher accounting costs: Many growing businesses invest in accounting software for startups or work with an accountant or CPA to manage accrual accounting effectively. While this adds to operating costs, it also reduces errors and helps maintain accurate financial reporting as the business scales.
- Cash flow blind spot: One of the biggest drawbacks of accrual accounting is that profitability doesn't always mean cash is available. Your income statement may show strong revenue because you've earned it, but if customers haven't paid their invoices yet, your bank balance may tell a very different story. Likewise, upcoming supplier payments or payroll obligations may not be immediately obvious if you're only looking at profit.
How to manage the cash flow gap that accrual accounting creates
Accrual accounting gives you a clearer picture of profitability, but it doesn't tell you how much cash you have available to run your business today. While your accounting says one thing, it might still not have happened in real time. That's because revenue and expenses are recorded before cash changes hands.
There is a significant gap between the reported profit and the cash available in the bank. This gap is one of the biggest financial challenges of growing businesses. The solution isn’t to avoid accrual accounting altogether. You need to monitor profitability and cash flow simultaneously. Here are a few ways to stay ahead of potential cash shortages:
- Review your cash flow statement alongside your P&L statement: Your P&L shows whether you're making money, while your cash flow statement shows whether enough cash is coming in to fund day-to-day operations.
- Monitor your accounts receivable aging report: Outstanding invoices, if not settled within their due time period, can result in cash flow bottlenecks. Reviewing receivables and following up on them helps you identify and collect overdue payments before they start affecting your working capital.
- Forecast upcoming cash commitments. Keep track of payroll, supplier payments, taxes, loan repayments, and other obligations, so you know what's leaving your account in the weeks ahead.
- Maintain a real-time view of your available cash. Cash balances change throughout the day. Having up-to-date visibility into incoming payments and outgoing expenses helps you make better spending and investment decisions.
This is where your finance tools like Aspire matter. It isn't just an accounting software; it's the business finance layer that helps you manage the cash and the reported profit behind your accruals. You get a real-time view of your available cash, manage incoming and outgoing payments from one platform, automate expense management, and keep idle balances working through the treasury3, earning up to 3.67% yield while remaining accessible.
When should you use accrual accounting?
There is no single turning point in your business journey where you need to switch to the accrual method of accounting. For many founders, this realization often comes naturally as operations become more complex.
1. You sell or buy on credit
Cash accounting doesn’t help you track and reflect transactions like invoicing customers after delivering products or services or if you have payment terms with suppliers. It is only recorded when money changes hands. Accrual accounting helps you keep track of those credit transactions when they are incurred. This way, you get a more accurate picture of your business activity
2. There is a gap between doing the work and getting paid
For various projects that your business works on, there is often going to be a significant amount of time between project completion and the payment date. Sometimes a month at a stretch. If you are running a consulting firm, marketing agency, software company, or professional services business, accrual accounting helps you recognize revenue you have earned instead of waiting for the actual payment to arrive.
3. Your business owns inventory
If inventory is a major part of your business, matching the cost of goods sold to the revenue generated becomes significantly important. Accrual accounting often makes it easier for you to measure your product profitability, manage any inventory costs, and prepare accurate financial statements.
4. You are preparing GAAP-compliant financial statements
Sometimes this switch isn’t optional but necessary. Public companies must prepare GAAP-compliant financial statements using accrual accounting. The IRS also requires certain businesses to use the accrual method once they exceed the applicable average annual gross receipts threshold or meet specific inventory and accounting requirements. Because these thresholds are adjusted periodically, it's worth checking the latest IRS guidance or speaking with your CPA before making the switch.
Founder tip: Many businesses switch earlier because it provides better visibility into profitability, supports faster decision-making, and makes future fundraising or expansion much easier.
How to switch from cash to accrual accounting
Switching from cash accounting to accrual accounting gives you a more accurate view of your business by matching revenue and expenses to the periods in which they are earned or incurred. You often need to revisit and identify outstanding receivables and payables, match prepaid expenses and deferred revenue, and most importantly, comply with IRS requirements.
1. Record outstanding receivables and payables
Your first step is to start identifying money that’s earned or spent but hasn’t changed hands yet. This includes customer invoices that haven’t been paid (accounts receivable) and supplier invoices and other unpaid bills (accounts payable). Adding these balances ensures a holistic list of transactions in your books.
2. Record prepaid expenses and deferred revenue
The next step is to review transactions where cash has moved, but related goods or services haven’t been fully delivered. This includes annual insurance premiums, software subscriptions paid upfront, customer retainers or prepaid contracts, or unearned subscription revenue. Recording these items correctly helps ensure revenue and expenses are recognized in the appropriate accounting periods.
3. Adjust your opening balances
Once receivables, payables, accruals, and deferrals have been recorded, update your opening balances to reflect the new accounting method. This creates a clean starting point for future reporting and ensures your financial statements remain consistent from one reporting period to the next.
4. File IRS Form 3115 if required
If you're changing your tax accounting method, you may need to file IRS Form 3115 (Application for Change in Accounting Method). The form notifies the IRS of the change and helps ensure your tax reporting remains compliant. Because the filing requirements can vary depending on your circumstances, it's worth reviewing the latest IRS guidance or working with a qualified tax professional.
5. Work with a CPA
Changing accounting methods affects both your financial statements and your tax reporting. A CPA can help you identify the necessary adjustments, prepare any required IRS filings, and ensure the transition is completed correctly.
Founder insight: Making the change at the beginning of a new financial year or reporting period is often cleaner, reduces reconciliation work, and makes it easier to compare financial performance going forward.
Is accrual accounting right for your business
The trade-off of accrual accounting is that it doesn’t reflect the cash available in your bank account. This is why most finance teams don’t just rely on accrual accounting alone. They pair it with real-time cash flow visibility to understand both how the business is performing and how much cash is available to fund growth.
Accrual accounting gives you a clearer picture of how your business is actually performing by recording revenue when it's earned and expenses when they're incurred. As your business grows, that visibility becomes increasingly important for budgeting, forecasting, fundraising, and making confident financial decisions.
FAQs
Should an LLC use cash or accrual accounting?
It depends on how the LLC operates. Cash accounting works well for many small LLCs with simple cash transactions. In contrast, accrual accounting is a better choice for LLCs that sell on credit, carry inventory, or want a more accurate view of profitability and financial performance.
When should you switch to accrual accounting?
You should switch to accrual accounting when your business starts selling on credit, managing inventory, handling long-term contracts or subscriptions, preparing GAAP-compliant financial statements, or raising capital. Some businesses are also required by the IRS to use the accrual method once they meet certain criteria.
Is accrual accounting harder than cash accounting?
Yes. Accrual accounting is more complex because it requires you to record revenue and expenses when they're earned or incurred, maintain adjusting entries, and track accounts receivable, accounts payable, and other accruals.
What is a disadvantage of accrual accounting?
The biggest disadvantage of accrual accounting is that it can show a profit even when cash hasn't been collected. This means a business may appear profitable on paper while still experiencing cash flow challenges.
What is the journal entry in accrual accounting?
A journal entry in accrual accounting records revenue or expenses when they're earned or incurred, even if cash hasn't changed hands. For example, recording an unpaid customer invoice debits accounts receivable and credits revenue.
