Quick answer: The two main accounting methods are cash basis (record income and expenses when money actually changes hands) and accrual basis (record them when they're earned or incurred, regardless of payment). Small businesses with under $30 million in average annual gross receipts can generally choose either method for tax purposes; most larger businesses, C corporations, and businesses carrying inventory must use accrual.
The cash method records transactions only when cash is received or paid. If you invoice a client in December but get paid in January, that income belongs to January under cash accounting. It's the default choice for freelancers, sole proprietors, and most service-based small businesses.
Use cash basis when you want:
The accrual method records income when it's earned and expenses when they're incurred, even if no money has moved. That December invoice counts as December income, regardless of when the client pays. It's the standard for businesses with inventory, accounts receivable, or significant credit transactions.
Use accrual basis when you want:
|
Feature |
Cash Basis |
Accrual Basis |
|
When income is recorded |
When payment is received |
When the sale is earned |
|
When expenses are recorded |
When payment is made |
When the expense is incurred |
|
Complexity |
Simple |
More complex |
|
Tracks A/R and A/P? |
No |
Yes |
|
GAAP-compliant? |
No |
Yes |
|
Best for |
Small service businesses, freelancers |
Businesses with inventory, credit sales, investors |
|
Tax timing control |
Higher |
Lower |
Cash basis usually gives small businesses more tax flexibility because you control timing. You could choose to delay sending an invoice or prepay an expense in December to shift it into the right tax year.
Accrual basis can be better when you have large outstanding receivables that you don't want to pay tax on before collecting, or when you carry inventory and need to match cost of goods sold to revenue.
The IRS allows most businesses with average gross receipts of $30 million or less (2025 threshold, adjusted for inflation) to choose either method. See IRS Publication 538 for the full rules.
On Schedule C (Profit or Loss from Business), sole proprietors check one of three boxes for accounting method: Cash, Accrual, or Other.
Most sole proprietors and single-member LLCs choose Cash because:
Choose Accrual on Schedule C if you carry inventory above the $30M threshold, or if you've already been keeping accrual-based books for other reasons (loans, investors, partners).
⚠️ Once you pick a method on your first return, you generally have to stick with it. Changing methods requires filing Form 3115 with the IRS.
Yes, but it requires IRS approval. File Form 3115 (Application for Change in Accounting Method) to request the change. Some changes are "automatic" (no fee, faster approval); others require advance consent.
Common reasons to switch:
You're required to use the accrual method if:
Otherwise, the choice is yours.
The hybrid method mixes cash and accrual, for example, using accrual for inventory and cost of goods sold, but cash for everything else. It's allowed by the IRS but must be consistent and clearly reflect income. This is what gets checked under "Other" on Schedule C.
Pick cash basis if you're a small service business, freelancer, or sole proprietor who wants simple books and better control over tax timing. Pick accrual basis if you carry inventory, sell on credit, need GAAP-compliant statements for investors or lenders, or exceed the IRS gross receipts threshold. When in doubt, consult a CPA as the method you choose on your first tax return is sticky, and switching later means filing Form 3115.