Cash vs Accrual Accounting: Which Should Your Startup Use?
A clear explanation of the two main accounting methods, with practical guidance on which is right for your startup at each stage.
Cash or accrual? It's one of the first accounting decisions every startup faces, and it's more important than many founders realize. The method you choose affects how you report revenue, how your financials look to investors, and whether you can pass due diligence scrutiny.
This guide explains both methods in plain English, shows you the real-world impact on your financials, and helps you choose the right approach for your startup's stage.
The Quick Answer
Our Recommendation
Use accrual accounting from the start. While cash basis is simpler, accrual is what investors expect, what GAAP requires, and what you'll need for Series A due diligence anyway. Starting with accrual saves the pain of converting later.
That said, let's dig into what each method means and why it matters.
Cash Basis Accounting Explained
The Cash Basis Rule
Revenue: Recognize when cash is received
Expenses: Recognize when cash is paid
Cash basis accounting is intuitive because it matches your bank account. When money comes in, it's revenue. When money goes out, it's an expense. Your profit equals cash in minus cash out.
Advantages of Cash Basis
Simple to Understand
No complex adjustments. Your P&L essentially matches your bank statement.
Easy to Maintain
No accrual entries, deferred revenue tracking, or prepaid amortization.
Shows Actual Cash Position
Your reported profit directly correlates to actual cash generated.
Disadvantages of Cash Basis
Doesn't Show True Performance
Revenue collected today for future services appears as today's income, distorting your actual business performance.
Not GAAP-Compliant
Generally Accepted Accounting Principles require accrual basis. Investors, auditors, and larger customers expect GAAP financials.
Easy to Manipulate (Unintentionally)
Pushing payments or collections between months can dramatically swing reported results in misleading ways.
Accrual Basis Accounting Explained
The Accrual Basis Rule
Revenue: Recognize when earned (service delivered or obligation satisfied)
Expenses: Recognize when incurred (benefit received)
Accrual accounting matches revenue to the period when you earn it, and expenses to the period when you benefit from them—regardless of when cash changes hands. This provides a more accurate picture of your business's actual economic performance.
Advantages of Accrual Basis
Shows True Economic Performance
Revenue and expenses are matched to the periods they relate to, giving you an accurate picture of profitability.
GAAP-Compliant
Required for audited financials. Expected by investors. Necessary for Series A and beyond.
Better for Decision-Making
Accurate profitability data helps you make informed decisions about pricing, hiring, and resource allocation.
Captures Full Financial Picture
Accounts receivable, accounts payable, deferred revenue, and prepaids all show up on your balance sheet.
Disadvantages of Accrual Basis
More Complex
Requires understanding of accruals, deferrals, and the monthly close process.
Cash Flow Doesn't Match P&L
You might show a profit while burning cash, or vice versa. This confuses some founders initially.
Requires More Expertise
Proper accrual accounting often requires a bookkeeper who understands it, or at minimum, more founder education.
Key Differences
| Aspect | Cash Basis | Accrual Basis |
|---|---|---|
| Revenue Recognition | When cash received | When earned (service delivered) |
| Expense Recognition | When cash paid | When incurred (benefit received) |
| Accounts Receivable | Not tracked | Shows money owed to you |
| Deferred Revenue | Not tracked | Shows prepaid obligations |
| GAAP Compliant | No | Yes |
| Complexity | Low | Moderate to High |
| Investor Ready | No | Yes |
Real-World Examples
Let's see how the same transactions look under each method.
Example 1: Annual Subscription Paid Upfront
A customer pays $12,000 on January 1 for a 12-month subscription.
Cash Basis
January: $12,000 revenue
Feb-Dec: $0 revenue
All revenue hits in January when cash is received.
Accrual Basis
Each month: $1,000 revenue
Jan balance sheet: $11,000 deferred revenue
Revenue recognized as service is delivered each month.
Example 2: Annual Insurance Paid Upfront
You pay $6,000 on January 1 for annual insurance coverage.
Cash Basis
January: $6,000 expense
Feb-Dec: $0 expense
Entire expense hits in January when paid.
Accrual Basis
Each month: $500 expense
Jan balance sheet: $5,500 prepaid expense
Expense recognized as benefit is received each month.
Example 3: Service Delivered, Payment Later
You complete a $5,000 consulting project in March. Client pays in April.
Cash Basis
March: $0 revenue
April: $5,000 revenue
Revenue appears in April when payment arrives.
Accrual Basis
March: $5,000 revenue + $5,000 A/R
April: A/R converts to cash
Revenue recognized when earned (project completed).
Why This Matters for SaaS
If you have annual subscriptions and use cash basis, your revenue will look wildly inconsistent—huge spikes when annuals renew, nothing in between. Investors will immediately flag this and require accrual restatement. See our guide on SaaS revenue recognition for more details.
Which Should Your Startup Use?
Decision Matrix by Stage
Pre-Revenue / Pre-Seed
Recommendation: Accrual preferred, cash basis acceptable
Low transaction volume means either method is manageable. Accrual builds good habits for later, but cash basis won't hurt you yet.
Seed Stage (Raised Capital)
Recommendation: Accrual
You now have investors who expect proper financial reporting. Start accrual now to avoid a painful conversion before Series A.
Pre-Series A
Recommendation: Accrual (required)
If you're not on accrual, convert now. Series A investors will require GAAP-compliant financials for due diligence.
Series A and Beyond
Recommendation: Accrual (non-negotiable)
At this point, accrual basis is assumed. You'll need GAAP financials for board reporting, investor updates, and any future raises or exits.
Special Considerations
SaaS/Subscription Business
Use accrual from day one. Deferred revenue and proper revenue recognition are central to your business model.
Professional Services
Accrual matters for matching project revenue to project costs. Cash basis distorts project profitability.
Hardware/Manufacturing
Accrual is essential for inventory accounting and cost of goods sold calculations.
Marketplace Business
Accrual helps properly account for gross vs net revenue and timing of fee recognition.
Switching from Cash to Accrual
If you're currently on cash basis and need to switch, here's what to expect:
The Conversion Process
Identify All Cash-to-Accrual Differences
Map out all accounts receivable, accounts payable, deferred revenue, prepaid expenses, and accrued liabilities.
Set Up Balance Sheet Accounts
Add the accounts you need: deferred revenue, prepaid expenses, accounts receivable, accrued expenses, etc.
Make Conversion Entries
Record journal entries to adjust from cash to accrual as of a specific date (usually year-end or quarter-end).
Restate Historical Financials
If needed for investors, restate prior periods on an accrual basis for comparability.
Conversion Is Painful
Converting after years of cash basis accounting can take weeks and cost thousands in accounting fees. The earlier you switch to accrual, the easier it is. If you're preparing for a raise, start the conversion at least 6 months out.
Get Help If Needed
A fractional CFO can oversee your conversion and ensure it's done correctly. They'll also help establish ongoing accrual accounting processes and train your bookkeeper.
Related Articles
Startup Accounting 101
Complete accounting fundamentals guide
SaaS Revenue Recognition
ASC 606 explained for startups
Chart of Accounts Template
Setting up your account structure
Monthly Close Process
Step-by-step checklist
Need Help With Your Accounting Setup?
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