Cash Basis Accounting

What is cash basis accounting?

Cash basis accounting is the simpler of the two main accounting methods. You record income when money hits your bank account and expenses when money leaves it. If a client pays you on March 15, that's when you record the income—regardless of when you did the work or sent the invoice.

Most small contractors and freelancers use cash basis accounting because it's straightforward and matches how they naturally think about their finances.

Cash basis vs. accrual accounting

The key differences:

• Cash basis — Record transactions when money moves. Simpler to manage.
• Accrual basis — Record transactions when they're earned or incurred. More accurate picture of profitability.

Pros and cons of cash basis

Cash basis accounting works well for many small businesses:

• Advantages — Easy to understand, shows actual cash on hand, simpler tax preparation
• Disadvantages — Can misrepresent true profitability, doesn't match income to the work that generated it, not suitable for larger businesses or those with inventory

The IRS allows most small businesses to use cash basis, but businesses with more than $25 million in average annual gross receipts generally must use accrual accounting.