Most small businesses under $5M in revenue use cash basis accounting because it’s simpler and matches actual cash flow. You record income when you receive payment and expenses when you pay bills.

Accrual accounting records income when you earn it and expenses when you incur them, regardless of when cash changes hands. This gives a more accurate picture of profitability but is more complex to maintain.

You need accrual accounting if you have inventory, if your revenue exceeds $5M, or if you’re seeking outside financing. Banks and investors want accrual-basis financials because they show economic reality better than cash basis.

Some industries work better with accrual even if not required. Construction companies with long-term projects need accrual to match revenue with the costs of earning it.

Your CPA can advise which method works best for your situation. You can change methods later if your business grows or circumstances change, but switching requires IRS approval and careful planning.