Your dental practice collected $80,000 in patient payments last month, but you provided $95,000 worth of services. Which number tells you the real story of your business performance?
If you’re using cash accounting, you’d see $80,000 and potentially make decisions based on incomplete information. Accrual accounting shows the full $95,000, giving you accurate insights into your business health. But switching accounting methods isn’t right for every business.
Here’s how to decide if accrual accounting benefits your specific situation and what the transition actually involves.
What is an Accrual in Accounting?
An accrual is a way to record revenue or expenses when they occur, not when cash changes hands. This accounting method gives you a more accurate picture of your company’s financial health by matching income and expenses to the periods when they actually happen.
For example, when you complete a project in December but don’t receive payment until January, accrual accounting records that revenue in December—when you earned it. The same principle applies to expenses. If you receive an invoice for services performed in December but pay it in January, the expense shows up in December’s financial records.
Types of Accruals
Accruals fall into two main categories:
Accrued Revenue occurs when you’ve provided goods or services but haven’t yet billed the customer or received payment. For example, if you complete consulting work in March but don’t invoice until April, you’d record accrued revenue in March.
Accrued Expenses are costs your business has incurred but hasn’t yet paid. Common examples include employee wages earned but not yet paid, utility bills for services already used, or interest that’s accumulated on a loan.
This approach differs from cash basis accounting, where transactions only appear when money moves in or out of your accounts. While cash basis is simpler, accrual accounting provides business owners with better insight into their operations. You can see what you’ve truly earned and what you actually owe, regardless of when payments are made or received.
Most growing businesses use accrual accounting because it follows Generally Accepted Accounting Principles (GAAP) and gives you the detailed financial reporting needed to make sound business decisions. It’s also required for companies that carry inventory or have annual revenues exceeding $25 million.
What is Accrual vs Cash Accounting?
As previously mentioned, the difference between accrual and cash accounting comes down to timing—specifically, when you record transactions in your books.
Cash accounting is straightforward. You record income when you receive payment and expenses when you pay them. If a client pays you in January for work you did in December, that revenue appears in January’s records. Similarly, if you pay a December invoice in January, the expense shows up in January. This method is simple and shows you exactly how much cash you have on hand at any given time.
Accrual accounting records transactions when they happen, not when money changes hands. Revenue is recorded when you earn it, and expenses are recorded when you incur them. Using the same example, work completed in December appears as December revenue, even if payment arrives in January. An invoice received in December shows up as a December expense, regardless of when you actually pay it.
Which Method Should Your Business Use?
Cash accounting works well for small businesses, sole proprietors, and companies with straightforward transactions and no inventory. It’s easier to manage and gives you a clear view of your cash flow.
Accrual accounting is better suited for growing businesses and is required for companies with inventory or annual revenues over $25 million. It provides a more accurate picture of your financial position by showing what you’ve truly earned and owe. This method also follows Generally Accepted Accounting Principles (GAAP), which many lenders and investors expect to see.
When Accrual Accounting Makes Sense for Your Business
To have a clearer picture of whether accrual accounting will work for you, here are some business situations that strongly benefit from accrual accounting methods.
You Have Significant Accounts Receivable
If you regularly invoice clients and wait 30, 60, or 90 days for payment, cash accounting creates misleading financials. A construction company might complete three major projects in Q4 but not receive payment until Q1. Cash accounting would show terrible Q4 performance and artificially strong Q1, making business planning nearly impossible.
Accrual accounting shows revenue when you earn it, giving accurate period-by-period performance measurement.
You Carry Inventory
IRS regulations require businesses with inventory to use accrual accounting. If you buy products to resell or manufacture goods, you need accrual methods to properly match inventory costs with sales revenue.
A medical practice purchasing supplies faces this requirement. Cash accounting can’t properly track inventory value or cost of goods sold.
You Need Accurate Job Costing
Businesses that manage multiple projects simultaneously need to match all project costs with project revenue. A law firm handling dozens of cases needs to know which matters are profitable, not just whether the firm collected more than it spent last month.
Accrual accounting enables true project profitability analysis by matching all revenues and costs to specific jobs, regardless of payment timing.
You’re Seeking Financing or Investors
Banks and investors require accrual-basis financial statements because they provide accurate business performance pictures. Lenders need to see your actual obligations and receivables, not just your cash position.
A growing company seeking a business line of credit will need accrual financials showing accounts receivable as assets and accounts payable as liabilities.
Your Revenue Exceeds $25 Million
IRS rules generally require businesses with average annual gross receipts above $25 million to use accrual accounting. If you’re approaching this threshold, transition before you’re forced to change mid-year.
You Need Better Business Planning
Cash accounting tells you what happened with cash. Accrual accounting tells you what happened with your business. If you’re making strategic decisions about pricing, hiring, expansion, or service offerings, you need the accurate performance data that accrual accounting provides.
Industry Examples
Different industries face unique financial timing challenges that make accrual accounting especially valuable. Here’s how it works in practice for businesses we serve.
Dental Practices
Most dental practices benefit significantly from accrual accounting. Insurance reimbursements take weeks or months, patient payment plans extend over time, and practices need to know true profitability per procedure and per provider.
A practice seeing strong cash collections might not realize certain procedures are unprofitable or insurance companies are consistently underpaying until accrual accounting reveals the full picture.
Construction Companies
Construction businesses typically must use accrual accounting due to inventory requirements and long project timelines. A project starting in October and completing in March needs proper revenue and expense matching across those months.
Percentage-of-completion revenue recognition under accrual methods shows profitability as projects progress, not just when final payments arrive.
Law Firms
Legal practices with billable hours and client retainers need accrual accounting to understand matter profitability. Cash accounting can’t properly match the costs of working on a case with the revenue that case generates when billing happens quarterly but work happens daily.
Nonprofits
Grant-funded nonprofits particularly benefit from accrual accounting. Multi-year grants need revenue recognition spread across grant periods, not just when cash arrives. Accrual methods properly match program expenses with the grant revenue funding those programs.
This gives board members and donors accurate pictures of program costs and sustainability rather than distorted views based on cash timing.
Hotels and Hospitality
Businesses with significant advance bookings and deposits must use accrual accounting to defer revenue until services are actually provided. A hotel collecting January deposits in November can’t recognize that as November revenue.
How to Switch to Accrual Accounting
Transitioning from cash to accrual accounting involves specific steps and timing considerations.
1. Choose Your Transition Timing
Most businesses switch at year-end to start fresh with accrual methods on January 1. This simplifies the transition and avoids mid-year complexity. Some businesses switch at their fiscal year-end if it is different from the calendar year.
2. Clean Up Your Current Books
Before switching, ensure your cash-basis books are accurate and complete. Reconcile all bank accounts, categorize transactions properly, and resolve any discrepancies. Starting with messy books makes the transition significantly harder.
3. Identify All Accounts Receivable and Payable
Document every outstanding invoice you’ve sent and every bill you owe. These become opening balances in your accrual system. A common mistake is missing receivables or payables, which distorts your opening balance sheet.
4. Record Prepaid Expenses and Deferred Revenue
Identify payments you’ve made for future periods (like prepaid insurance) and payments you’ve received for future services (like retainers or deposits). These require special entries to properly allocate to future periods.
5. Set Up Your Chart of Accounts
Accrual accounting requires additional accounts like Accounts Receivable, Accounts Payable, Prepaid Expenses, and Deferred Revenue. Your chart of accounts needs restructuring to accommodate accrual methods.
6. Implement Proper Accounting Software
Spreadsheets can’t handle accrual accounting effectively. You need proper accounting software like QuickBooks Online that automatically creates accrual entries, tracks receivables and payables, and generates accrual-basis financial statements.
7. Establish Month-End Close Processes
Accrual accounting demands systematic month-end procedures: recording unbilled revenue, accruing expenses, reconciling accounts, and reviewing financial statements. This requires more discipline than cash accounting’s simpler approach.
8. Get Professional Support
Most businesses benefit from professional accounting support when making this transition. We help identify all necessary adjustments, set up systems properly, train your team on accrual methods, and ensure accurate implementation.
Attempting this transition alone often results in errors that require expensive cleanup later.
Common Accrual Accounting Challenges (And Solutions)
While accrual accounting provides accurate financial insights, it can create confusion if you’re not familiar with how it works. Here are the most common challenges business owners face and how to address them.
Challenge: Cash Flow Confusion
Accrual accounting can show profit while you’re short on cash, or show losses while your bank account looks healthy. This disconnect confuses many business owners.
Solution: Run both accrual financial statements (for business performance) and cash flow reports (for cash management). Professional accountants provide both views, giving you complete financial clarity.
Challenge: Increased Complexity
Accrual methods require more bookkeeping work—recording invoices as they’re sent, entering bills when received, making adjusting entries monthly, and tracking multiple balance sheet accounts.
Solution: Proper accounting software automates much of this complexity. Professional bookkeeping support handles the technical details while you focus on running your business.
Challenge: Tax Timing Differences
You might owe taxes on accrued revenue you haven’t collected yet, or miss deductions for expenses you’ve incurred but haven’t paid.
Solution: Work with tax advisors who understand accrual timing differences and can plan estimated tax payments appropriately. Some businesses maintain cash-basis tax reporting while using accrual for management reporting.
Challenge: Learning Curve
Your team needs to understand accrual concepts to properly record transactions. The receptionist entering patient payments needs to apply them against specific invoices. The project manager needs to submit billable time promptly.
Solution: Professional accountants provide training and ongoing support. We create procedures your team can follow and answer questions as they arise.
Get Professional Support for the Transition
Switching accounting methods isn’t a DIY project for most businesses. The technical accounting knowledge, system setup requirements, and potential for costly mistakes make professional support essential.
Professional accountants handle the entire transition. Here at MBS, we’ve helped dental practices, construction companies, law firms, nonprofits, and businesses across industries make this transition smoothly. The result is financial clarity that drives better decisions, supports growth, and gives you confidence in your numbers.Ready to explore whether accrual accounting is right for your business? Contact us today to discuss your specific situation, challenges, and goals. We’ll help you understand the benefits, costs, and implementation process for your unique needs.