The answer depends on your business size, industry, and what you need from your financial statements. Cash accounting records income when you receive payment and expenses when you pay them. Accrual accounting records income when you earn it and expenses when you incur them, regardless of when money actually moves.

For most small service businesses, cash basis works well and keeps things simple. You complete a project in December and the client pays in January, so you recognize that income in January. Your tax liability aligns closely with your actual cash position. The monthly bookkeeping is more straightforward because you’re essentially tracking what flows through your bank account.

Accrual makes more sense when there’s a significant gap between performing work and collecting payment. A contractor who invoices $50,000 in December but won’t get paid until February sees December as a slow month under cash basis and February as a windfall. Neither reflects reality. Accrual shows revenue in December when it was earned, giving you an accurate view of when your business actually performed.

The IRS allows most small businesses to choose either method. If your average annual gross receipts are under $29 million, you generally qualify for cash basis. C corporations over that threshold and certain businesses with inventory face additional rules, but most small businesses can pick whichever method fits better.

Consider accrual if you have significant accounts receivable or accounts payable that create timing differences. Businesses seeking loans or outside investment typically need accrual-based financials because lenders want to see true profitability, not just cash movement. Construction companies and others who need accurate job costing usually benefit from accrual as well.

Stick with cash if you run a straightforward service business where you get paid quickly after delivering work. Cash basis offers simplicity and gives you some control over income timing for tax purposes. If a client wants to pay in late December, you can wait until January to deposit the check and push that income into the next tax year.

Once you choose a method, switching requires IRS approval through Form 3115. It’s not impossible but adds complexity. Think about which approach fits your business now and where you expect to be in a few years.

The method you choose affects day-to-day bookkeeping workflows. Accrual requires tracking what you’ve earned but not billed, what you’ve billed but not collected, and what you owe but haven’t paid. Cash basis just needs to reconcile to your bank and credit card statements.

If you’re unsure which direction to go, start with what your accountant recommends based on your entity type and tax situation. Most San Diego small businesses operate on cash basis until they reach a size or complexity that demands accrual. A San Diego bookkeeping service can help you set up either approach correctly from the start and maintain consistency going forward.