What is cash method accounting? Definition, key features, and how it works in 2025

If you’re running a small business or working as a solopreneur, cash method accounting might be the simplest way to track your finances. Let’s explore how this approach works, what makes it different from other accounting methods, and why it could be the right fit for your business.

Cash accounting method definition

The cash accounting method—also called cash basis accounting—is an accounting approach where you record income when you get paid, and you record expenses when you actually pay them.

Jump to:

• Key features of cash accounting
• How does cash-based accounting work?
• Advantages and disadvantages of cash method accounting
• The 3 methods of accounting
• Cash vs. accrual accounting method
• Small business examples of cash basis accounting
• Tax implications of using the cash method

Key features of cash accounting 

The cash method helps keep accounting simple since it tracks money only when it changes hands. Here are the key features you need to know:

You record income when you receive payment

With cash accounting, you don’t count income when you send an invoice. You record it when the cash hits your account. This keeps your process straightforward and tied to real cash flow.

H3: You record expenses when you pay them

You only track expenses after you’ve paid them. If you receive a bill today but pay it next week, you don’t record it until the money leaves your hands.

Simple and easy to maintain

There’s no need to manage accounts receivable or accounts payable. If you want an easy way to match your books to your bank statements, cash accounting gives you that simplicity.

Real-time insight into cash position

Cash accounting gives you a real-time view of how much cash your business actually has on hand, which helps you make informed short-term financial decisions.

Eligibility and limitations for using the cash method

Not every business can use the cash method of accounting. In the U.S., the IRS has specific rules about who qualifies and who doesn’t based on your business type and annual income.

Who can use it

Most small businesses can use the cash method, especially if they:

• Have average annual gross receipts under $31 million over the past three tax years (as of 2025).
• Operate as sole proprietors, partnerships, or small corporations that meet the income limit.
• Sell products and have inventory, as long as they treat inventory as non-incidental supplies or follow what’s in their financial statements (see Tax Cuts and Jobs Act).
• Are a qualified personal service corporation (PSC), regardless of income.

This method is especially common among service-based businesses, like consultants, freelancers, and local contractors, because it’s easy to use and offers helpful tax flexibility.

Who can’t use it

Some businesses are restricted from using the cash method. You may be required to use the accrual method if you:

• Are a C corporation or a partnership with a C corp partner.
• Have average annual gross receipts that exceed the $31 million limit.
• Are a tax shelter as defined by the IRS in section 448(d)(3).

The IRS outlines these rules in Publication 538, which explains when you must switch to the accrual method based on business structure and revenue.

If you're not sure which rules apply to your business, it's a good idea to talk with an accountant or tax advisor.

How does cash-based accounting work?

Cash-based accounting works by recording income and expenses only when money actually changes hands. Let’s look at the process step-by-step:

Step 1: Provide a product or service

You do the work, sell a product, or deliver a service just like you normally would. But under the cash method, nothing gets recorded yet.

Step 2: Receive payment

Once your customer pays (e.g., cash, check, card, or bank transfer), you record that income in your books. If you haven’t been paid, you don’t log anything yet.

Step 3: Pay a business expense

When you pay for something (like rent, software, or supplies), that’s when you record the expense. You don’t track unpaid bills until the money actually leaves your account.

Step 4: Keep records based on cash movement

You only record transactions when money comes in or goes out. That means your books reflect your real-time cash position, not what’s owed to you or what you owe someone else.

Step 5: Use reports to monitor cash flow

Because your records follow cash flow, reports like your income statement show how much money you’ve earned and spent, not what’s pending. It helps you stay focused on what you can actually spend today.

Impact of the cash method on financial statements

When you use cash method accounting, it changes how your financial statements look, especially your income statement and balance sheet.

Income statement

Your income statement (also called a profit and loss statement) shows revenue only when you receive payment, not when you earn it. Likewise, you only list expenses when you actually pay them. This means your profits may look higher or lower than they really are, depending on the timing of your cash flow.

For example, if you complete a big project in December but don’t get paid until January, that income won’t show up until the next year’s income statement.

Balance sheet

With the cash method, your balance sheet is more basic and less detailed. You won’t track accounts receivable (money owed to you) or accounts payable (bills you owe). Instead, you’ll mostly see your current cash balance, along with assets like equipment and liabilities like loans.

This keeps your balance sheet simple, but it might not give lenders or investors a full picture of your financial health.

What does it mean to “record transactions”

When you use cash accounting, “recording a transaction” simply means writing it down when the money actually moves, not when a sale is made or a bill is received. If no cash changes hands, you don’t log anything yet. Here’s how that works in practice.

When is revenue recognized (upon receipt of cash)?

You recognize revenue when you receive payment, not when you send an invoice or complete a job.

Example: You finish a project for a client on April 19 and invoice them the same day. They pay you on May 5. You record that income on May 5, when the money hits your account, not in April.

When are expenses recorded (upon payment)?

You record expenses when you actually pay them, not when you receive a bill or agree to make a purchase.

Example: You get a $500 bill for office supplies on July 10, but don’t pay it until July 25. You record the $500 expense on July 25, when the cash leaves your account.

How are prepaid expenses or customer prepayments handled?

When it comes to prepaid expenses, you record the whole expense when you pay it. You don’t spread it out over the year.

Example: You pay $1,200 in January for 12 months of accounting software. Under cash accounting, you record the full $1,200 as an expense in January.

Customer prepayments work similarly. If a client pays you before you’ve delivered a product or service, you still count it as income when the cash comes in.

Example: A client pays you a $2,000 deposit in March for work you’ll do in April. You record that $2,000 as March income because you’ve received the money, even if you haven’t done the work yet.

Advantages and disadvantages of cash method accounting

The cash method is a popular choice, but like any accounting method, it has its trade-offs.

Here’s a quick look at the advantages and disadvantages to help you decide if it’s the right fit for your business: