Should my small business use cash or accrual accounting?

What accrual accounting means in practice

Accrual accounting records a sale the day you invoice or deliver the work, not the day the customer pays, and records an expense the day you incur it, not the day you write the cheque. That means your books carry accounts receivable for money owed to you, accounts payable for money you owe, and sometimes prepaid expenses or work in progress for costs and revenue that span more than one period.

Consider a landscaping company that finishes a job on March 28 and invoices the customer that day, but the customer does not pay until April 15. Under accrual accounting, the revenue belongs in March, the month the work was actually completed, even though the cash lands in April. A supplier invoice for the materials used on that job works the same way in reverse: the expense is recorded when the bill is received, not when it is eventually paid.

The CRA requires accrual accounting for almost every business filing a T2125 or a T2 corporate return. This is the method most bookkeeping software defaults to, and it is the one an accountant uses to prepare year-end financial statements regardless of how a business manages day-to-day cash.

Who can actually use the cash method

The cash method, where income is recorded only when received and expenses only when paid, is available to a narrow group: farmers, fishers, and certain self-employed commission sales agents who meet specific conditions tied to how their income is earned. Outside those categories, the CRA expects accrual reporting, and switching to cash without qualifying is not an option worth pursuing, since a return filed on the wrong basis can require restating more than one year at once if it is caught later.

Businesses that do qualify for the cash method often find record-keeping considerably simpler, since there is no need to track which invoices remain outstanding at year-end or which supplier bills are still owed. Our bookkeeping work with farm operations usually starts by confirming which method actually applies before anything else is set up, since a farm that also runs a value-added side business can end up with one activity on cash and another on accrual.

The choice also shows up directly on the return. A sole proprietor's T2125 has a specific box indicating which method was used for the year, and a corporation's GIFI-coded T2 return assumes accrual throughout, since there is no equivalent cash-method box once a business incorporates.

Why a healthy bank balance is not the same as a profit

A cash-basis view of a business, how much sits in the bank right now, and an accrual-basis view, whether the business is actually profitable, can tell two very different stories in the same month. A contractor who just received a large deposit for a project not yet started looks flush with cash but has not earned that revenue yet under accrual rules; a business waiting on several large invoices can look strapped in the bank while its income statement shows a healthy profit.

Relying only on the bank balance to judge how a business is doing is one of the more common ways owners misjudge their own numbers, and it is a particularly easy mistake for a growing business, where rising sales often mean rising receivables and rising inventory long before they mean more cash in the account. Our answer on what financial statements a small business needs covers why the income statement and the bank balance answer different questions, and why a business can be profitable on paper while still running short on cash month to month.

A retail business waiting on a large wholesale account to pay, for example, might show thin cash reserves in a given month even while its income statement reports the healthiest margin it has posted all year. Reading only the bank balance in that situation can push an owner to cut spending or delay hiring based on a temporary timing gap rather than any real decline in the business.

What changed for professionals with work in progress

Lawyers, accountants, dentists, and other designated professionals used to be able to elect out of including work in progress in income, effectively reporting on a billed basis rather than an accrual basis for unbilled work. That election was phased out starting with the 2017 taxation year, and professionals now include work in progress in income the same way any other accrual-basis business does.

The transition meant a practice with a large amount of unbilled work at its year-end saw a one-time bump in taxable income as that work was brought onto the books, and the rules allowed the impact to be spread over more than one year to soften it. A professional practice that has not revisited how work in progress is valued since that change should confirm with an accountant that the current method still matches the rules, since an outdated valuation approach can understate income at every year-end going forward.

How we handle this for clients

We keep every client's books on the accrual basis the CRA expects as part of our ongoing bookkeeping service, then build a cash-flow view alongside it in a rolling cash flow forecast so the owner sees both pictures without confusing one for the other. QuickBooks and similar platforms can also toggle a report between cash and accrual basis on demand, which is useful for a quick check on what has actually cleared the bank, but it is never a substitute for accrual-based books at filing time, and we do not let clients treat the cash-basis toggle as their real set of numbers.