Cash Basis vs Accrual Accounting: Which One, and When You Must Switch

Cash basis records income when money arrives and expenses when money leaves. Accrual accounting records income when it is earned and expenses when they are incurred — regardless of when cash moves. The difference sounds technical and is anything but: the two methods can show the same business as profitable or loss-making in the same month, and only one of them can tell you whether the profit is real.

The same month, both ways

A consultancy in March: delivers a 10,000 € project (client pays in May), pays 3,000 € in salaries for March work, and receives 6,000 € from a February invoice.

	Cash basis	Accrual
Income	6,000	10,000
Expenses	3,000	3,000
March result	3,000	7,000

Cash basis reports the arrival of old revenue and calls it March's performance. Accrual reports what March actually produced: a 10,000 € project against 3,000 € of costs incurred earning it. The accrual result answers the question management is actually asking — did this month's work pay for itself? — while the cash figure answers a different one: what happened to the bank balance? Both questions matter; only one of them is what "profit" means.

What each method gets right

Cash basis is simple, cheap, and immune to one specific self-deception: it never shows paper profit from customers who don't pay. For a sole trader with immediate payments and no inventory — a market stall, a barber — it approximates accrual closely enough not to matter.

Accrual matches revenue with the costs of earning it, which makes periods comparable and margins meaningful. The price is machinery: receivables, payables, adjusting entries for accruals and deferrals, and the discipline of period cut-offs. That machinery is precisely what double-entry bookkeeping provides — accrual accounting is its native mode.

The classic accrual trap deserves its own sentence: profit is not cash. An accrual P&L can show healthy profit while receivables balloon and the bank empties — which is why the cash flow statement exists, and why "profitable" companies still fail. Accrual doesn't hide this; it reports it, in the balance sheet, for anyone who reads past the P&L.

Who may use cash basis in the EU

The pattern across EU countries is consistent: companies keep accrual books; the smallest unincorporated businesses may use cash records.

• Limited companies prepare statutory financial statements under national GAAP or IFRS, and both are accrual frameworks — in Lithuania, companies keep their books on the accrual principle under Business Accounting Standards (VAS). A UAB doing cash-basis bookkeeping is not choosing an option; it is failing its obligations.
• Sole traders and the self-employed can typically use cash-based records below national thresholds — in Lithuania, individual activity (individuali veikla) income is generally recognized on a cash basis for personal income tax.
• VAT runs on its own rules regardless of your books: it is invoice-driven by default, with special cash-accounting schemes for small businesses in some member states.

The specifics are national law and change; the structure — accrual for companies, cash tolerated at the small end — is stable across the EU.

When you must switch (and when you should)

You must switch when you incorporate. The day the business becomes a company, statutory accrual accounting applies — this is the most common forced transition, and it is cleanest done from a real opening balance: receivables, payables, inventory and prepayments established as of day one, not reconstructed later.

You should switch earlier if any of these are true:

• Customers pay on invoice terms — once money lags work by weeks, cash-basis months stop meaning anything.
• You carry inventory — buying stock is not an expense; selling it is. Cash basis cannot express this.
• You take prepayments or subscriptions — cash received for undelivered work is a liability, not income; only accrual says so.
• Anyone outside reads your numbers — banks, investors and buyers will accrue your figures anyway, on worse information than you have.

The switch itself is an opening-balance exercise: establish what is owed to you, what you owe, what you hold and what you've prepaid, post it as the opening entry, and record forward on accrual.

The accrual engine, automated

The historical objection to accrual — too much bookkeeping for a small team — is an automation argument now. Nordlet's ledger is accrual by construction: a sales invoice posts revenue and a receivable the moment it is issued, payments clear the receivable when bank imports match them, prepayments sit as liabilities until delivery, and the revenue recognition engine defers and releases subscription income period by period, including automatically at period close. The bookkeeping cost that once justified cash basis is the part software does.

FAQ

What is the difference between cash basis and accrual accounting?

Cash basis records income and expenses when money moves; accrual records income when earned and expenses when incurred. Accrual measures performance, cash basis measures bank movements — and the two can tell very different stories about the same month.

Which is better for a small business?

If payments are immediate and there's no inventory, cash basis is adequate and simpler. The moment invoicing terms, stock, or prepayments appear, accrual is the only method whose "profit" means anything — and with automated bookkeeping its overhead has mostly disappeared.

Can a limited company use cash basis accounting in the EU?

For statutory books, effectively no — EU national frameworks (including Lithuanian VAS) require companies to account on the accrual principle. Cash-based simplifications exist mainly for sole traders and the self-employed below national thresholds.

Does VAT follow cash or accrual rules?

Neither of your choosing: VAT has its own timing rules, generally invoice-driven, with optional cash-accounting schemes for small businesses in some countries. Your bookkeeping method doesn't change your VAT obligations.

How do I switch from cash to accrual?

Fix a switch date and build the opening balance: unpaid customer invoices (receivables), unpaid supplier bills (payables), inventory on hand, prepayments made and received. Post that as the opening entry and record on accrual from that day. Incorporation is the natural moment — it's also when the switch becomes mandatory.