Most articles on cash basis vs accrual accounting for small business end with "it depends" and leave you exactly where you started. So here is the stance, up front: if you run a service business under $25M in revenue and you do not hold inventory, use cash basis. It matches how you already think about the money — it is in the account or it is not — and it is what the IRS lets almost every small service shop use. The rest of this is why, plus the two real exceptions.
The short answer for a service business
Cash basis means you record income when the money lands in your bank and expenses when they leave it. Accrual means you record income when you earn it (you finished the job) and expenses when you owe them (the bill arrived), regardless of when cash actually moves. For a roofer, an HVAC tech, or a landscaper, cash basis is simpler, cheaper to keep, and — this is the part that matters — it tells you the truth about whether you can make payroll on Friday.
The $25M line
The IRS lets most businesses under an average $25M in gross receipts (indexed up over time) use the cash method. A tiny fraction of service businesses ever cross that line, and if you do, your accountant will tell you long before the IRS does. For everyone else, cash basis is on the table — the question is whether it fits, not whether it is allowed.
Cash basis: you book money when it hits the bank
On cash basis, a job you finished in March but got paid for in April is April income. A truck repair you put on a card in March but pay off in April is an April expense. The books follow the bank statement. That is the whole appeal: your profit-and-loss statement and your checking account are telling the same story, so a good month on paper is a good month in the account.
It is also less work. You are not tracking who owes you and who you owe as separate ledgers to make the P&L balance — the payment event is the record. That is why cash basis is the default for a one-to-fifteen-person shop that would rather be on a roof than in a spreadsheet.
Accrual: you book it when it's earned or owed
Accrual splits the timing. The day you finish a $9,000 install, that $9,000 is revenue — even if the customer has 30 days to pay and the cash is still sitting on your accounts-receivable list. Likewise, the day a $2,000 material invoice arrives, it is an expense, even if you have not cut the check. Accrual matches revenue to the costs that earned it in the same period, which is genuinely more accurate for measuring performance. The catch is that "accurate performance" and "cash I can spend" stop being the same number.
The same month, both ways, side by side
Take one March for a small shop. You completed $40,000 of work. Customers actually paid you $28,000 of it in March; the other $12,000 is invoiced but unpaid. You ran up $22,000 of costs, and paid $18,000 of them in March, leaving $4,000 in bills sitting on the counter.
- Cash basis March: income $28,000 − expenses $18,000 = $10,000 profit, and your bank balance moved by roughly that.
- Accrual March: income $40,000 − expenses $22,000 = $18,000 profit — a bigger, prettier number that does not match a single dollar you can spend.
Same month, same business, two profit figures $8,000 apart. Neither is lying. Accrual is measuring the work you did; cash basis is measuring the money you actually have. For deciding whether you can hire, buy a trailer, or take a draw, the cash number is the one that keeps you solvent.
Why accrual can show a profit with an empty checking account
This is the "why is my business profitable but has no cash" trap, and it is the single most common reason a growing service business panics. On accrual, that unpaid $12,000 counted as profit the moment you finished the job — so your P&L says you made $18,000 while your account holds far less. You feel poor and the statement says rich. The gap is your receivables (money earned, not collected) and your payables (bills counted, not paid) sitting between the two.
Profit is an opinion, cash is a fact
Accrual profit is a well-reasoned opinion about a period. Cash is what cleared the bank. A business does not go under because its accrual P&L looked bad — it goes under because the account hit zero. Cash basis keeps those two things from drifting apart on you.
The two times you actually need accrual
The honest answer is not "cash basis always." There are two situations that legitimately push a service business toward accrual, and it is worth knowing whether either is you.
- 1.You carry real inventory or large materials. If you stock parts, hold product on shelves, or float big material spends across months, cash basis can distort a period badly — a $30,000 pre-buy hammers one month and flatters the next. A parts-heavy operation is usually better matched by accrual (and may be required to use it for that inventory).
- 2.An outside party requires it. A bank underwriting a large loan, a bonding company, an investor, or an acquirer will often want accrual statements because they measure performance independent of collection timing. If someone who controls your capital asks for accrual books, you produce accrual books.
Notice what is not on that list: "you got bigger." Growth alone does not force accrual. A $3M landscaping company with no inventory and no lender demanding otherwise can run cash basis and be completely fine. Do not switch just because it feels more grown-up.
How to pick and move on
For the large majority of service shops, this decision takes about a minute once you stop overthinking it.
Check for inventory
Do you hold stock or float big material buys across months? If no, that argument for accrual is gone.
Check who is asking
Does a bank, bonding company, or investor require accrual statements right now? If no one is asking, you are free to choose.
Default to cash basis
If both answers are no — which is most service businesses — run cash basis. Your books match your bank, and your P&L tells you what you can actually spend.
That is exactly why Mortar keeps its books on cash basis: your imported bank activity is the source of truth, so the profit-and-loss statement you read is the money that really moved. If you want to get more out of that statement once it is set, read how to read your profit and loss statement. And once you have picked a method, do not confuse the two numbers that quietly kill margin — the difference between margin and markup trips up more owners than accounting method ever will.
Is cash basis or accrual better for a contractor?
For most small contractors with no inventory and no lender demanding otherwise, cash basis is better: it is simpler to keep and your books match your bank balance, so you can see whether you can make payroll. Larger contractors carrying significant materials or working under long jobs, bonds, or bank financing often need accrual.
Why is my business profitable but has no cash?
That is almost always an accrual effect: your profit-and-loss statement counted a job as income the day you finished it, but the customer has not paid yet. The profit is real; the cash is stuck in your receivables. Cash basis avoids this by only booking income when the money actually lands.
Can I switch from cash basis to accrual later?
Yes. You can change accounting methods, though a switch generally requires filing IRS Form 3115 and making some one-time adjustments, so it is a job for your accountant. The practical advice: start on cash basis, and only switch when inventory or an outside party genuinely forces it.
Does the IRS let a small service business use cash basis?
For the large majority, yes. Most businesses under an average $25M in gross receipts (a threshold that rises over time) can use the cash method, and few service shops without inventory come close. Confirm your specific situation with a tax professional, but for a typical small service business cash basis is squarely allowed.
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