How to Move from Cash to Accrual Method: A Complete Guide for Business Owners
When it comes to accounting, one of the most important decisions business owners face is whether to use the cash method or the accrual method. While many small businesses start with the cash method because it’s simpler, growth often requires a transition to the accrual method for better accuracy and compliance.
In this article, we’ll explore what these two methods mean, why businesses switch, how to transition smoothly, and what it means for your financial reporting. We’ll also include a Q&A section, a call to action, and helpful resources to guide you further.
Understanding the Cash Method
The cash method of accounting recognizes income and expenses when money changes hands.
Revenue is recorded when payment is received.
Expenses are recorded when payment is made.
This makes it easy for small businesses to see exactly how much cash they have at any given time. However, it doesn’t always provide the full picture of financial health because it ignores outstanding invoices and unpaid bills.
Understanding the Accrual Method
The accrual method of accounting records income and expenses when they are earned or incurred, regardless of when money is received or paid.
Revenue is recognized when a service is provided or a product is delivered—even if the client hasn’t paid yet.
Expenses are recognized when the obligation occurs, not when the payment is made.
This gives a more accurate picture of profitability and financial performance, which is essential for growing businesses.
Why Businesses Move from Cash to Accrual
Switching to accrual accounting may be required or simply beneficial, depending on your situation. Some reasons include:
IRS Requirements – The IRS requires certain businesses to use accrual if their average annual gross receipts exceed $25 million (as of 2023).
Improved Financial Insight – Accrual accounting provides a clearer picture of long-term profitability and financial position.
Better for Growth – Businesses with complex operations, inventory, or multiple revenue streams benefit from accrual’s detailed reporting.
Investor and Lender Expectations – Banks, investors, and stakeholders typically prefer accrual-based financial statements because they show more accurate performance.
Steps to Transition from Cash to Accrual
Shifting from cash to accrual requires adjustments in your books. Here’s a general process:
1. Review IRS Rules
Check if your business is required to switch due to size, industry, or specific IRS guidelines. Some industries (like inventory-heavy businesses) often must use accrual.
2. Adjust Accounts Receivable
Record outstanding invoices that have been issued but not yet collected. These should be added to your books as income under accrual.
3. Adjust Accounts Payable
Add any unpaid expenses or bills as liabilities. This ensures your obligations are reflected properly.
4. Record Prepaid Expenses and Unearned Revenue
If you’ve received payments for services not yet rendered (unearned revenue) or prepaid for services not yet used, these must be adjusted in your books.
5. Update Your Accounting System
Ensure your accounting software (such as QuickBooks Online) is set to accrual basis reporting. You may need help from a bookkeeper or accountant to set this up properly.
6. File IRS Form 3115 (If Applicable)
If you’re permanently changing your accounting method, you must file Form 3115, Application for Change in Accounting Method, with the IRS.
7. Seek Professional Help
The transition can be complex. A professional bookkeeper or CPA can ensure your records are accurate and compliant.
Benefits of Switching to Accrual
Better long-term planning – Accrual gives insight into future cash flow and obligations.
Improved reporting – Financial statements become more accurate and useful for decision-making.
Compliance-ready – Accrual is required for many growing businesses and industries.
Stronger investor confidence – Investors and banks see accrual-based statements as more reliable.
Common Challenges During the Switch
While the benefits are clear, switching can present challenges:
Complex Adjustments – Moving outstanding invoices, bills, and unearned revenue requires detailed work.
Learning Curve – Business owners used to seeing “cash in, cash out” may find accrual reporting more complex.
Potential Tax Impact – The timing of recognizing income and expenses may shift, potentially affecting taxable income.
Working with an experienced bookkeeper or accountant can help ease these challenges.
Q&A: Moving from Cash to Accrual
Q: How do I know if I’m required to switch to accrual?
A: If your average annual gross receipts exceed $25 million (IRS threshold), or if your business holds inventory, you may be required. Always confirm with a tax professional.
Q: Can I switch back to cash later?
A: Switching back typically requires IRS approval and another filing of Form 3115. It’s not something you should plan to do frequently.
Q: How long does the transition take?
A: It depends on the complexity of your business and records. For small businesses, it may take a few weeks. For larger companies, it can take months.
Q: Will switching affect my taxes?
A: Yes. Income and expenses may be recognized in different periods, so timing of tax obligations can change. Consulting a CPA is strongly recommended.
Q: Can QuickBooks handle accrual accounting?
A: Yes. QuickBooks Online can generate reports in both cash and accrual. You just need to ensure your data is entered correctly for accrual reporting.
How Brecken Business Solutions Can Help
At Brecken Business Solutions, we’ve helped countless small businesses successfully transition from cash to accrual accounting.
We can:
Review whether you’re required to switch.
Set up your accounting software for accrual.
Adjust accounts receivable, accounts payable, and prepaid expenses.
Guide you through filing IRS Form 3115 if needed.
Provide ongoing support to keep your books accurate and compliant.
Call to Action
Contact us today to ensure your move from cash to accrual is seamless, compliant, and beneficial for your business growth.
