Every business keeps score with one of two methods. Cash accounting records a sale when the money arrives and an expense when you pay it. Accrual accounting records a sale when you earn it and an expense when you incur it, whatever the bank balance says. The choice changes your reported profit month by month, what a lender sees, and sometimes your tax bill. Most small businesses start on cash because it is simple; the question is when that stops being good enough.
Key Takeaways
- Cash: income when received, expenses when paid. Simple, and it matches your bank balance.
- Accrual: income when earned, expenses when incurred. It shows what the business actually did in a month, even if invoices are still unpaid.
- Most small businesses may use the cash method for taxes: for 2026 the IRS test is average annual gross receipts of $32 million or less over the prior three years.
- Lenders, investors and buyers usually want accrual statements, so many owners keep their management books on accrual even when the tax return is on cash.
- Changing a tax accounting method generally means filing Form 3115 with the IRS, so talk to your tax adviser before you switch.
One invoice, two methods
Suppose a Dallas consulting firm finishes a $10,000 project on December 20, sends the invoice that day, and the client pays on January 10. It pays a $2,000 subcontractor on December 28.
| Cash method | Accrual method | |
|---|---|---|
| The $10,000 project | Income in January, when the money arrives | Income in December, when the work is done |
| The $2,000 subcontractor | Expense in December, when paid | Expense in December, when the work was received |
| December profit shown | A $2,000 loss | $8,000 profit |
Both are correct under their own rules, and over a long period they add up to the same total. But in the single month, the cash books say the firm lost money and the accrual books say it earned $8,000. That difference is why the method matters when someone else reads your numbers.
What the IRS allows
The IRS describes the two methods this way: under the cash method you generally report income in the year you receive it and deduct expenses in the year you pay them; under accrual you generally report income when you earn it and deduct expenses when you incur them. Which one you may use for taxes depends mostly on size.
- The gross receipts test. A business whose average annual gross receipts for the prior three tax years are at or below an inflation-adjusted limit can use the cash method. The limit is $32 million for 2026 (it was $31 million for 2025). Nearly every business in the $1 million to $20 million range passes comfortably.
- Inventory. A business that passes the test can generally choose not to keep a formal inventory for tax purposes, but it must still use a method that clearly reflects income. Businesses that carry inventory should confirm their treatment with a tax adviser.
- Tax shelters and some larger or related businesses cannot use the cash method.
So for most Dallas small businesses the IRS lets you pick. The better question is which method gives you the information you need to run the company.
Why many owners keep accrual books anyway
- Lenders and investors usually ask for accrual-basis statements because they show receivables, payables and the true profit of each month.
- Buyers value a business on normalized earnings, which are far easier to prove from accrual books. See our guide to business valuation.
- You see the real month. A big customer paying late no longer makes a good month look like a bad one, and a large annual bill paid in one month no longer wrecks that month’s profit.
- Prepayments and deposits are recorded against the work still to be done, not as profit on the day the cash arrives.
It is common to keep management books on accrual and have the tax return prepared on the cash method, with a routine adjustment between the two. Your tax preparer handles that conversion each year.
Signs it is time to move from cash to accrual
- You invoice customers and wait 30 to 90 days to be paid, so your monthly profit swings with collection timing.
- A bank, landlord or investor has asked for accrual financial statements.
- You take deposits or annual prepayments for work delivered later.
- You carry inventory or run several locations or entities.
- You are thinking about selling the business in the next few years.
- You want budgets and forecasts you can trust. A rolling forecast and the KPIs in our financial KPIs guide assume accrual numbers.
How a change of method works
Changing the accounting method you use for taxes is a formal change. Generally you file Form 3115, Application for Change in Accounting Method, and the one-time effect of switching (items already counted under the old method) is calculated and spread over time rather than hitting a single year. Because the details depend on your situation, involve your tax adviser before you change anything. Changing only your internal books to accrual does not change your tax method, and is a good first step.
How Ledger Tree works
Ledger Tree is a founder-led firm working mainly with established, privately held businesses in the $1 million to $20 million revenue range across Dallas–Fort Worth. We keep monthly books on whichever basis suits you, convert to accrual when a lender, buyer or growth plan calls for it, and coordinate the tax side with your tax filing. See our bookkeeping services, or call (214) 807-2440.
Not sure which method fits your business?
We will look at how you invoice and get paid, show you what your last year looks like on both methods, and recommend what makes sense for your size and plans.
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Frequently Asked Questions
What is the difference between cash and accrual accounting?
Cash accounting records income when you receive it and expenses when you pay them. Accrual accounting records income when you earn it and expenses when you incur them, regardless of when money changes hands.
Can my small business use the cash method for taxes?
Most can. A business whose average annual gross receipts for the prior three tax years are $32 million or less (the 2026 limit) can generally use the cash method, unless it is a tax shelter or otherwise excluded. Businesses with inventory should confirm their treatment with a tax adviser.
Why do lenders ask for accrual financial statements?
Accrual statements show receivables, payables and the profit earned in each period, which gives a lender a truer picture of the business than the timing of payments in a bank account.
Can I keep accrual books but file taxes on the cash method?
Yes. Many businesses keep management books on accrual and prepare the tax return on the cash method, with a routine adjustment between the two. Your tax preparer makes that adjustment each year.
How do I change my accounting method for taxes?
Generally by filing Form 3115, Application for Change in Accounting Method, with the IRS. The one-time effect of the change is calculated and usually spread over several years. Involve your tax adviser before switching.
When should a growing business move to accrual accounting?
Common triggers are slow-paying customers that distort monthly profit, a lender or investor asking for accrual statements, deposits or prepayments, inventory or multiple entities, and plans to sell the business.
Sources: IRS Publication 538, Accounting Periods and Methods (cash and accrual methods, Form 3115); IRS Rev. Proc. 2025-32 and the IRS Q&A on the section 163(j) limitation (inflation-adjusted gross receipts amounts: $31 million for 2025 and $32 million for 2026). Worked example and preparation steps reflect Ledger Tree Financial Group practice. Published 2026-10-28.