When you’re setting up accounting software for the first time, there’s usually a screen that asks whether you want cash or accrual accounting. Most people click through without thinking about it. That’s a mistake.

The choice affects how your financials look, when you pay taxes, and whether your reports actually help you run your business. Let me explain what this means in practical terms.

Cash Basis: What You See Is What You’ve Got

Cash basis is simple. You record income when money hits your bank account. You record expenses when money leaves. That’s it.

If you invoice a client in March but they don’t pay until April, that income shows up in April’s reports. Same with expenses - if you get a bill in December but pay it in January, it’s a January expense.

Most sole traders and small businesses under $10 million in revenue can use cash basis for tax purposes in Australia. It matches how you actually think about money. You’ve got funds or you don’t.

The main advantage? Cash basis tells you exactly how much money you have right now. Your reports match your bank balance. When you look at profit for the month, you know that’s real money that came in.

Accrual Basis: The “Proper” Way

Accrual accounting records transactions when they happen, not when money moves. Invoice someone in March? That’s March income, even if they take 60 days to pay.

This is how larger businesses and public companies must operate. It gives a more accurate picture of business performance over time. You can see if you’re profitable before considering the timing of payments.

The problem for small businesses? Accrual reports can be misleading. Your profit and loss might show $50,000 profit while your bank account is empty because customers haven’t paid yet. I’ve seen business owners panic over this disconnect.

Software Defaults and What They Mean

QuickBooks Online defaults to accrual but lets you switch views. Xero is accrual-only for the most part, though you can run cash-based reports. MYOB gives you the choice upfront.

Here’s the thing: if you’re using accrual in your software but cash basis for your tax return, you’re creating extra work. You’ll need to convert everything at year-end, or your accountant will charge you to do it.

Most accountants prefer accrual because that’s what they learned. But if you’re a tradie, consultant, or retail shop doing under $2 million a year, cash basis is usually simpler and more relevant to how you operate.

When Accrual Actually Helps

There are situations where accrual makes sense even for small businesses:

If you carry inventory, accrual accounting handles it better. You can track cost of goods sold properly and understand margins.

If you have long-term projects that span multiple months, accrual helps you match revenue with related expenses. A builder working on a three-month project can see if that job was actually profitable.

If you’re planning to raise investment or sell the business, investors and buyers expect accrual accounting. They want to see the underlying business performance, not just cash timing.

The Hybrid Approach Nobody Talks About

Some businesses run accrual in their accounting software but think in cash terms for day-to-day decisions. They’ll check the bank balance and cash flow forecasts more than the P&L.

This isn’t ideal, but it’s common. If you’re doing this, at least make sure your software can generate both types of reports easily. Xero’s “Cash Summary” feature does this. QuickBooks Online has cash and accrual toggles on most reports.

Tax Implications You Can’t Ignore

In Australia, if your business turns over less than $10 million, you can choose either method for tax purposes. Once you choose, you’re generally stuck with it unless you apply to the ATO to change.

If you’re registered for GST, you’ll report on either a cash or accrual basis. This should match your accounting method to avoid confusion.

One firm I spoke with that specializes in business AI solutions pointed out that their automated reconciliation tools work better when your accounting method matches your actual business operations. Makes sense - the AI can predict cash flow more accurately when the data reflects reality.

Making the Choice

For most small businesses, cash basis is the right answer. It’s simpler, matches how you think about money, and requires less adjustment at tax time.

Consider accrual if you:

• Have significant inventory
• Run projects over multiple months
• Need to show investors your business performance
• Have more than $10 million in revenue
• Plan to sell the business soon

Your accounting software can handle either method. The question is which one helps you make better decisions. For most of us, that’s seeing exactly what money we have and when we’ll actually receive payment.

Don’t just accept the default. Think about how you run your business and pick the method that makes your reports useful instead of confusing.