Cash-basis accounting records revenue and expenses only when money moves in or out of your bank account, while accrual accounting records them when they’re earned or incurred, regardless of payment timing. Accrual gives a much clearer picture of your true performance, especially once you have subscriptions, invoices, or deferred revenue, so the decision isn’t if a venture-backed startup should switch, but when.
A Simple Rule of Thumb for Founders
For bootstrapped, very small, low‑complexity startups, it’s typically time to transition to accrual accounting once you:
- Have recurring or deferred revenue,
- Are serious about raising institutional capital, or
- Need clear visibility into margins and unit economics.
What’s the Difference Between Cash and Accrual Accounting?
Here are five simple, startup-focused examples that show how cash vs. accrual recognition differ, and how each method impacts your startup.
1. Annual SaaS Contract
- Scenario: You sell a 12‑month SaaS subscription for $12,000, paid upfront on January 1.
- Cash-basis:
- Recognize $12,000 of revenue in January when the cash hits the bank.
- Accrual:
- Recognize $1,000 of revenue each month from January through December, because that’s when the service is delivered.
- Impact:
- Cash accounting overstates January and understates the rest of the year, while accrual shows steady revenue that matches usage.
2. Invoicing on Net 30 Terms
- Scenario: You finish a project on March 25 and invoice $20,000 on Net 30; the client pays on April 20.
- Cash-basis:
- Recognize $20,000 of revenue in April when you get paid.
- Accrual:
- Recognize $20,000 of revenue in March when the work is completed and the invoice is issued; book accounts receivable until the cash arrives.
- Impact:
- Under cash accounting, March looks weaker and April looks stronger than it really is, while accrual shows when value was actually created.
3. Contractor Bill Received but Paid Later
- Scenario: A marketing agency finishes work in June and sends an $8,000 invoice due July 15; you pay it in July.
- Cash-basis:
- Record $8,000 of expenses in July when cash leaves your account.
- Accrual:
- Record $8,000 of expense in June when the service is received; book accounts payable until it’s paid in July.
- Impact:
- Cash accounting makes June’s margins look better than they truly were, while accrual reflects the real cost of June’s activities.
4. Prepaid Annual Software
- Scenario: On January 1, you pay $24,000 for a 12‑month CRM subscription.
- Cash-basis:
- Record $24,000 of expenses in January when it’s paid.
- Accrual:
- Record a $24,000 prepaid asset on January 1, then expense $2,000 per month from January to December as the software is used.
- Impact:
- Cash accounting makes January look very unprofitable and the rest of the year artificially better, while accrual spreads the cost over the actual benefit period.
5. December Work, January Payroll
- Scenario: Employees earn $50,000 of salary in December, but the paycheck hits on January 2.
- Cash-basis:
- Record $50,000 of payroll expense in January when cash goes out.
- Accrual:
- Record $50,000 of payroll expense and a wages payable liability in December; reverse the liability when you pay in January.
- Impact:
- Cash accounting understates December expenses and overstates January, while accrual matches costs to the period in which the work was actually done.
These examples show the core idea: cash accounting tracks when money moves, while accrual accounting tracks when value is earned or consumed, giving founders a clearer view of true performance and unit economics.
Early Days: When Cash-Basis Is Usually Fine
Very early, simple startups can reasonably start on a cash basis if:
- You have few transactions and mostly pay-as-you-go revenue (customers pay at the moment of service).
- The founder is handling bookkeeping, and simplicity is critical.
- You’re pre-VC, pre-revenue or very low revenue, and not yet presenting detailed financials to institutional investors.
At this stage, cash-basis can help with straightforward cash planning and low-cost compliance, but it becomes limiting as soon as you scale.
Clear Signals That It’s Time to Move to Accrual
Founders should strongly consider switching to accrual accounting when one or more of the following is true:
- You have recurring or contract-based revenue (SaaS, subscriptions, multi‑month contracts). Matching revenue to the period it’s earned becomes crucial.
- You invoice customers and get paid later (AR and payment terms). Cash-basis can make you look artificially “healthy” or “unhealthy” depending on timing.
- You’re raising or have raised institutional capital. VCs and many lenders expect accrual-basis, GAAP‑aligned financials for serious Seed, Series A, and later rounds.
- Your transactions and headcount are growing (multiple products, teams, or geographies). You need accurate margins and expense matching to manage the business.
In practice, most venture‑backed startups either start by using accrual accounting or transition by the time they are preparing for a substantial Seed or Series A raise.
Regulatory Triggers: When Cash-Basis Isn’t Allowed
Beyond investor expectations, tax rules can force a change:
- The IRS restricts cash accounting for certain larger businesses and specific types of entities once average annual gross receipts exceed thresholds over a three‑year period.
- Public companies and those preparing for IPO must follow US GAAP, which requires accrual accounting.
Even before you hit those limits, switching earlier, on your own terms, is usually easier than being forced to change under time pressure.
Practical Considerations Before You Switch
Moving from cash to accrual is a project, but a manageable one with the right help. Founders should:
- Pick the right timing
- Ideally just before or after a fiscal year‑end, so you can restate one clean year and move forward consistently.
- Clean up and reconcile existing books
- Make sure your cash‑basis records match bank accounts and correct obvious categorization errors first.
- Build an accrual framework
- Implement processes for accounts receivable, accounts payable, revenue recognition, and expense accruals that align with your business model.
- Work with a startup‑focused accounting firm
- Experienced teams can convert prior periods, design your chart of accounts, and produce simultaneous cash‑ and accrual‑view reports so founders still have an easy view of runway and burn.
The payoff is investor‑grade financials, better forecasting, and fewer surprises when you’re in diligence. An accounting firm that specializes in startups, like Kruze Consulting, can help you plan and execute the switch to accrual accounting. Contact us for more information.
