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What is the difference between cash and accrual accounting?

Cash accounting records income when money hits your bank account and expenses when you pay them. Accrual accounting records income when you earn it and expenses when you incur them, regardless of when cash actually moves.

Here’s a simple example. You finish a project on January 28 and send the invoice that day. The customer pays you on February 15. Under cash accounting, that’s February income because that’s when you received the money. Under accrual accounting, it’s January income because that’s when you completed the work and billed for it.

The same logic applies to expenses. You receive a materials bill in March but don’t pay it until April. Cash accounting shows it as an April expense. Accrual shows it in March when you received the bill and created the obligation.

This timing difference can make your monthly financial picture look very different. A month where you sent out $30,000 in invoices but only collected $8,000 from previous work looks completely different under each method. Cash shows $8,000 in revenue. Accrual shows $30,000. Neither is wrong. They’re just measuring different things.

Most small businesses use cash accounting because it’s simpler and aligns with what you see in your bank account. When your balance goes up from a customer payment, your books show income. When it goes down for a business purchase, your books show an expense. There’s an intuitive connection between your bank statement and your profit and loss report.

The IRS allows businesses to choose cash accounting if average annual gross receipts are under $25 million over the prior three years. That covers nearly every small business in Northwest Arkansas. Some businesses with inventory historically had to use accrual, but tax law changes have relaxed those requirements for smaller companies.

Accrual accounting gives a more accurate picture of long-term profitability because it matches revenue with the period when you actually performed the work. If you bill a big project in December but don’t collect until January, accrual shows the revenue in the year you did the work. This matters for understanding true performance, but it also means you might owe taxes on income you haven’t received yet.

The method you choose affects tax planning flexibility. Cash basis lets you control timing to some degree. Need to reduce taxable income this year? Delay sending invoices until January or prepay certain expenses in December. Accrual doesn’t offer that same flexibility because transactions record based on when they occur, not when money moves.

For monthly bookkeeping, consistency matters more than which method you pick. Switching methods mid-year creates confusion, and changing methods from year to year requires IRS approval. Pick one that fits your business and stick with it.

If you’re not sure which method you’re currently using or which makes more sense for your situation, a bookkeeper near Bentonville can review your setup and explain the practical implications for your specific business. The right choice depends on your industry, your billing cycles, and how you want to approach tax planning.

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More Questions

What records do I need to keep for an IRS audit?

Keep documentation that proves your income and expenses. This includes bank statements, receipts, invoices, payroll records, and anything that supports the numbers on your tax return. Most records should be kept for at least three to seven years.

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How do I correct errors on previous tax returns?

File an amended return using Form 1040-X for individuals or the appropriate form for your business entity type. You generally have three years from the filing date to make corrections and claim any refund you're owed.

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How do I handle change orders in my bookkeeping?

Change orders should be recorded as additions to the original job in your accounting system. Get written approval before starting work, then track the additional costs and revenue separately so you can see whether each change order was profitable.

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How do I separate overhead costs from job costs?

Overhead costs are general business expenses like rent and insurance. Job costs can be traced directly to specific projects. Set up your chart of accounts to separate them and code every transaction consistently.

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How long does it take a bookkeeper to clean up messy books?

Most cleanups take 1-4 weeks depending on how far behind you are and how many transactions need sorting. A few months of backlog is quicker than years of disorganized records.

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How do I handle 1099 reporting for contractors?

Collect W-9 forms before paying any contractor, track all payments throughout the year, and file 1099-NEC forms by January 31 for anyone paid $600 or more for services. The key is preparation throughout the year, not scrambling in January.

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Oliver Bookkeeping Solutions offers monthly bookkeeping, payroll, and accounting services to small businesses in Benton County and across Northwest Arkansas.

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