A Guide To Accrual Accounting

You pull up your financials expecting a strong quarter, and the numbers look great. Then you check the bank account and wonder where the money went. Or the opposite: the bank looks healthy, but your P&L tells a different story. If either of those scenarios sounds familiar, the issue often isn’t your business. It’s your accounting method.

The way you record revenue and expenses shapes what your financials actually tell you. For many small businesses, accrual accounting is the method that closes that gap. Unlike the cash method, which records transactions only when money changes hands, accrual accounting records revenue when it’s earned and expenses when they’re incurred. The result is a financial picture that reflects what’s actually happening in your business, not just what’s cleared your bank account.

This guide covers what accrual accounting is, how it works in practice, when it’s required, and how to decide whether it’s the right move for your business. Whether you’re preparing for a bank loan, heading into a fundraising round, or simply trying to get a more reliable read on your numbers, here’s what you need to know.

What Is Accrual Accounting?

Accrual accounting is an accounting method that records revenue when it’s earned and expenses when they’re incurred, regardless of when cash actually moves. Under the accrual basis of accounting, a sale counts the moment you deliver the service or product, not when the client pays the invoice. And an expense counts when you receive the goods or services, not when you write the check.

The contrast with cash accounting is direct. Under the cash method, you only record transactions when money changes hands. Simple, intuitive, and workable for a very small business. The problem is that cash-basis books can paint a misleading picture. Revenue appears when invoices get paid, not when work is done. Expenses show up when bills are settled, not when they’re owed.

Here’s a quick example. A consulting firm completes a project in March and sends a $15,000 invoice. The client pays in April. Under cash accounting, that $15,000 shows up as March revenue. Under accrual basis accounting, it shows up as March revenue, because that’s when the work was done and the income was earned.

That single difference compounds across every transaction in your business. Over time, accrual accounting produces financial statements that genuinely reflect performance. Cash accounting produces statements that reflect timing.

How Does Accrual Accounting Work?

The mechanics of accrual accounting are built on a concept called the matching principle: revenue and expenses are recorded in the period when they occur, and matched to each other. If you deliver a service in March, you record the revenue in March. If you incur a payroll expense in March, even if payday falls in April, you record that expense in March. The goal is for your financials to reflect actual business activity, period by period.

In practice, this means your books include entries beyond just cash. You track what’s owed to you (accounts receivable), what you owe others (accounts payable), income you’ve earned but not yet invoiced, and costs you’ve incurred but not yet paid. Here’s how the main types of accrual accounting entries work.

Accrued Revenue

Accrued revenue is income that’s been earned but not yet received in cash or invoiced. This is common in professional services and SaaS businesses, where delivery of value and billing often happen on different timelines.

Say a software company delivers a full month of service in March under a contract billed quarterly. At the end of March, they’ve earned that revenue but haven’t issued an invoice yet. Under the accrual method, they record the earned revenue in March. The journal entry: debit accounts receivable (money owed to you), credit revenue. When the invoice is eventually paid, the entry is settled. The revenue has already been recognized in the right period.

Accrued Expenses

Accrued expenses are costs that have been incurred but not yet paid. The most common example is payroll that crosses a month-end boundary.

If your employees work the last week of March but payday falls in early April, March’s expenses should still reflect that labor cost. Under the accrual method, you record a debit to salaries expense and a credit to accrued liabilities in March. When you run payroll in April, you clear that liability. Your March P&L accurately captures the cost of running the business in March, regardless of when the cash leaves your account.

Prepaid Expenses and Deferred Revenue

These are the flip side of accruals. A prepaid expense is a payment made before the value is received. If you pay six months of business insurance upfront in January, you don’t expense the full amount in January. You record it as a prepaid asset and recognize one month’s worth of expense each month as coverage is used.

Deferred revenue is the mirror image. If a client pays you a retainer before work begins, you don’t recognize that as income immediately. You record it as a liability (money you owe in services), and recognize it as revenue month by month as you deliver the work. Both treatments are standard components of how accrual basis accounting matches financial activity to the right period.

Accrual Accounting vs. Cash Accounting: What’s the Difference?

The core difference between accrual accounting vs. cash accounting comes down to timing. Cash accounting records transactions when money moves. Accrual accounting records them when activity occurs. That distinction has significant consequences for how your financial statements read and what decisions you can make from them.

Cash accounting is simpler. There’s less bookkeeping, fewer entries to track, and a direct line between your bank balance and your books. For a business with straightforward transactions and no significant receivables or payables, it can work fine. The IRS still allows many small businesses to use the cash method (more on the thresholds below).

The problem with cash basis accounting is that it can give you a distorted picture of performance. A strong month might look strong simply because several large invoices cleared at once, not because the business actually had a strong month operationally. A slow month might look fine because you paid fewer bills. For businesses with any complexity in their revenue or expense timing, that distortion makes the financials hard to use for real decision-making.

	Cash Basis	Accrual Basis
Records revenue	When cash is received	When it is earned
Records expenses	When cash is paid	When incurred
Complexity	Lower	Higher
GAAP compliant	No	Yes
Best for	Very small, simple businesses	Growing businesses with receivables/payables

Cash basis has real advantages for very small or simple businesses. But for companies with recurring revenue, service contracts, significant vendor relationships, or plans to grow, the gap in accuracy starts to cost you more than the simplicity is worth.

When Is Accrual Accounting Required?

Whether you’re required to use accrual accounting depends on a few factors: your revenue, your legal structure, and the expectations of the people reviewing your financials. Here are the three main triggers to understand.

GAAP Compliance

If you’re preparing audited financial statements, seeking investor capital, or issuing financials that lenders will rely on, you’re almost certainly operating in GAAP territory. GAAP accrual accounting is the standard for U.S. Generally Accepted Accounting Principles, and it requires the accrual method. No exceptions. If your business is approaching a Series A, working with institutional lenders, or heading toward an audit, accrual basis is part of the picture.

IRS Revenue Thresholds

For tax purposes, the IRS allows many small businesses to use the cash method. But that changes as revenue grows. In 2025, the IRS defines a small business as one with average annual gross receipts of $31 million or less over the prior three years. If your business exceeds that threshold, you’re generally required to use the accrual method for tax reporting. The threshold is adjusted annually for inflation, so it’s worth confirming the current figure with your CPA each year.

Voluntary Adoption

Many growing businesses switch to accrual before they’re required to. The most common reason: better data. When your books run on accrual, you can see what’s actually happening in the business rather than when payments happen to clear. For companies in SaaS, consulting, or professional services, where the gap between delivery and payment can span weeks or months, that accuracy pays dividends in planning and decision-making.

How to Make the Switch

Switching from cash to accrual accounting requires filing IRS Form 3115 (Application for Change in Accounting Method). This form notifies the IRS of the change and includes a Section 481(a) adjustment, which accounts for the cumulative difference between how income and expenses were recorded under your old method versus your new one. It ensures no items are double-counted or missed in the transition. Because the calculation requires detailed account balances and a solid understanding of both methods, this is a process worth doing with a CPA who handles accounting method changes regularly.

What Are the Benefits of Accrual Accounting for Small Businesses?

The case for accrual basis accounting is ultimately an accuracy argument. Your financials reflect when business activity happens, not when cash moves. That shift has practical downstream effects that matter more the larger your business gets.

A More Accurate Picture of Profitability

Under the accrual method, revenue and expenses land in the same period as the activity that created them. If you had a strong month operationally, that shows up in your P&L whether or not the invoices have cleared. If you took on significant vendor costs in a given month, those costs appear in the period that created them. The result is financials you can actually use to evaluate performance.

Stronger Forecasting and Budgeting

When your books track what’s owed to you and what you owe, you have a real-time view of what’s coming, not just what’s arrived. Accounts receivable tells you money in the pipeline. Accrued liabilities tell you obligations on the way. That visibility makes budgeting and cash flow forecasting substantially more reliable than cash-basis books, which only show you what’s already happened.

Credibility with Banks and Investors

Lenders and investors expect GAAP-compliant financials. If you’re pursuing a bank loan, a line of credit, or outside investment, accrual-basis statements are often a baseline requirement. Cash-basis financials may not give a lender the information they need to underwrite the relationship. Making the switch proactively puts you in a stronger position before those conversations start.

Better Visibility Into Receivables and Payables

One of the quieter benefits of accrual accounting is the discipline it creates around tracking what’s owed and what you owe. Accounts receivable and accrued expenses are live line items in your books, not an afterthought. That visibility helps reduce the cash surprises that catch cash-basis businesses off guard when a large payable comes due or an invoice goes unpaid longer than expected.

What Are the Challenges of Accrual Accounting?

Accrual accounting delivers better data, but it comes with trade-offs worth understanding before you make the switch.

Added Complexity and Month-End Rigor

Maintaining accurate accrual books requires more consistent, disciplined bookkeeping than the cash method. You need to track open invoices, record expense accruals at month-end, and reconcile items that cross period boundaries. For a business relying on occasional bookkeeping help or basic software, the step-up in complexity can be real. Month-end closes take longer and require more review.

Profit on Paper vs. Cash in the Bank

This is the gap that surprises many business owners who switch. Under accrual accounting, you can show a profitable month on your P&L while cash in the bank is flat or even declining. Revenue is recognized when earned, not when paid. That’s accurate, but it also means your income statement and your bank balance can tell different stories at any given moment. Understanding the difference between accrual profit and actual cash flow is essential, not optional, when you’re running on the accrual method.

Higher Cost of Accurate Books

The additional complexity of accrual accounting typically means higher bookkeeping costs. More entries, more reconciliation, more month-end work. For businesses doing their own books or relying on minimal accounting support, that gap is often where errors appear: missed accruals, deferred revenue not recognized on schedule, prepaid expenses not amortized. The cost of maintaining accurate accrual books is one of the arguments for working with a dedicated accounting partner rather than handling it in-house.

Is Accrual Accounting Right for Your Business?

A few signals suggest it’s time to make the move. If you’re in professional services, SaaS, or any business where the timing between delivering value and receiving payment is rarely the same day, accrual accounting will give you a more honest picture of performance. The same is true if you’re carrying significant receivables or payables, approaching the IRS revenue threshold, or preparing for a fundraise or bank relationship where GAAP financials are expected.

The common thread is this: the more complexity your business has, and the more decisions you’re making based on financial data, the more the accuracy of accrual basis matters.

If you’re ready to make the switch, or want help determining whether now is the right time, Milestone’s accounting team works with small and mid-market businesses to manage exactly this transition. From handling the IRS filing to restructuring your books, the team brings CPA-level expertise to the process so it’s done right the first time. Learn more about Milestone’s accounting and bookkeeping services at.

Frequently Asked Questions About Accrual Accounting

What is the difference between accrual accounting and cash accounting?

Cash accounting records revenue and expenses when cash actually changes hands. Accrual accounting records them when they’re earned or incurred, regardless of payment timing. The practical result: cash accounting reflects what’s cleared your bank, while accrual basis accounting reflects what’s actually happening in your business. For companies with any lag between service delivery and payment, the difference can be significant.

Is accrual accounting required for small businesses?

Not always. Many small businesses can use the cash method for tax purposes, provided their average annual gross receipts don’t exceed the IRS threshold, which is $31 million for 2025 (adjusted annually for inflation). However, GAAP accrual accounting is required for any business preparing audited financials or issuing statements that lenders or investors will rely on. Some businesses are also required to switch as they grow beyond the IRS threshold.

What is the matching principle in accrual accounting?

The matching principle is the foundation of accrual accounting. It holds that revenue and expenses should be recorded in the period in which they occur and matched to each other. If you incur payroll costs in March, those costs belong in March’s financials, even if payday is in April. Matching ties financial statements to actual business activity rather than to when transactions happen to settle.

What are the most common types of accruals?

The two main categories are accrued revenue (income earned but not yet received or invoiced) and accrued expenses (costs incurred but not yet paid, like payroll across a month-end boundary). Beyond those, businesses regularly work with prepaid expenses, which are payments made in advance of receiving the benefit, and deferred revenue, which is cash received before services are delivered.

How do I switch from cash basis to accrual accounting?

Switching requires filing IRS Form 3115, the Application for Change in Accounting Method. The form includes a Section 481(a) adjustment that accounts for the cumulative difference between how items were treated under your old method versus the new one. The process involves detailed account-level calculations and should be handled with a CPA. Done correctly, it prevents any double-counting or omission of income and expenses in the transition year.

Can a small business use accrual accounting without an accountant?

Technically yes, but it’s difficult to do accurately without accounting expertise. Accrual accounting requires consistent month-end processes, correct treatment of accruals and deferrals, and regular reconciliation of receivables and payables. The more complex your revenue and expense timing, the greater the risk of material errors. For most small businesses, the cost of working with a CPA or bookkeeper familiar with the accrual method is offset by cleaner books and fewer corrections down the line.