Cash Accounting vs. Accrual: Which Method Makes Sense for Your Handmade Business?
You sold $4,000 worth of products in December but won't receive payment until January. On cash accounting, you made $0 in December. On accrual accounting, you made $4,000. Which is correct? Both. But only one reduces your tax bill and shows real profitability. Here's how to choose.
Accounting method choice is one of the first decisions handmade business owners make—often without realizing they're making it. The IRS requires you to pick either cash basis or accrual basis accounting and stick with it consistently. Most makers default to cash accounting because it's simpler. But is it the right choice?
This decision impacts your tax liability, cash flow visibility, and profitability measurement. For makers selling on Etsy or Shopify with revenue under $25 million, you have flexibility. This guide shows you which method fits your business model, how to switch if needed, and what the IRS actually cares about. Understanding your accounting method is essential for building an accurate monthly P&L statement.
The Core Difference: When You Count Money
Cash Basis Accounting
You record revenue when you receive cash and expenses when you pay cash. It doesn't matter when you shipped the product or when you received the invoice—only when money changes hands.
Example: December Holiday Orders
- • December 20: You ship $4,000 in holiday orders
- • January 5: Customers pay via Etsy/Shopify (platform deposits to your account)
- Cash basis revenue in December: $0
- Cash basis revenue in January: $4,000
Accrual Basis Accounting
You record revenue when you earn it (ship the product) and expenses when you incur them (receive goods/services), regardless of when cash moves.
Example: December Holiday Orders
- • December 20: You ship $4,000 in holiday orders
- • January 5: Customers pay via Etsy/Shopify
- Accrual revenue in December: $4,000
- Accrual revenue in January: $0 (already counted)
Why This Matters for Taxes
The IRS taxes you based on your chosen accounting method. If you use cash accounting, that $4,000 is taxable in January (next tax year). If you use accrual, it's taxable in December (current tax year). This timing difference can shift thousands in tax liability between years.
Cash Accounting: Simplicity & Tax Deferral
Best for: Solo makers with under $100k annual revenue, minimal inventory, and straightforward transactions (you make it, sell it, get paid quickly).
Advantages
- ✓ Simplicity: Matches your bank account—easy to track
- ✓ Tax deferral: Delay taxes by delaying cash collection
- ✓ Cash flow clarity: Shows exactly what you can spend today
- ✓ No tracking receivables: If you haven't been paid, it doesn't exist
- ✓ IRS-approved for small businesses: Under $25M revenue = automatic eligibility
Disadvantages
- ✗ Profitability distortion: Doesn't match revenue to expenses
- ✗ Inventory problems: Doesn't account for unsold inventory value
- ✗ Misleading metrics: Can show profit when you're actually losing money
- ✗ Poor growth visibility: Hard to see real business trends
- ✗ Loan/investor issues: Banks want accrual statements
The Inventory Trap with Cash Accounting
Maria makes candles. In November, she buys $3,000 in wax, wicks, and containers to prepare for holiday sales. Under cash accounting, she records $3,000 in expenses immediately—even though she hasn't sold a single candle yet.
In December, she sells $8,000 worth of candles (customers pay immediately). Her cash accounting shows:
Reality: Her true profit was ~$5,000 ($8,000 revenue - $3,000 materials). Cash accounting distorted both months, making November look disastrous and December look incredible—when neither was true.
Accrual Accounting: True Profitability Picture
Best for: Makers with inventory, significant accounts receivable (wholesale, custom orders with deposits), or anyone planning to scale, seek funding, or sell the business.
Advantages
- ✓ Matches revenue to expenses: Shows true profit per period
- ✓ Inventory tracking: Reflects value of unsold goods
- ✓ Better decision-making: See real profitability trends
- ✓ Investor/lender friendly: GAAP-compliant financials
- ✓ Business sale readiness: Clean books = higher valuation
Disadvantages
- ✗ Complexity: Must track receivables, payables, inventory
- ✗ Tax acceleration: Pay taxes before you receive cash
- ✗ Doesn't match bank account: Profitable on paper, broke in reality
- ✗ More bookkeeping: Likely need accounting software or CPA
- ✗ IRS scrutiny: More complex = more audit risk if done wrong
Decision Framework: Which Method Should You Choose?
Choose Cash Accounting If:
- • You have <$100k annual revenue
- • Minimal inventory (made-to-order or quick turnover)
- • You get paid immediately upon sale (Etsy, Shopify, craft fairs)
- • You want simplicity and don't need bank financing
- • You're okay with distorted monthly profitability for tax deferral benefits
Choose Accrual Accounting If:
- • You carry significant inventory (>$10k)
- • You have accounts receivable (wholesale, net-30 terms, deposits)
- • You need to show investors or lenders clean financials
- • You want accurate month-to-month profitability tracking
- • You plan to scale, hire employees, or sell the business
The Hybrid Approach (Modified Cash Basis)
Many small makers use a modified cash basis: cash accounting for taxes, but track inventory and receivables internally for decision-making. This gives you tax simplicity while maintaining operational visibility.
How it works: Use cash basis for your tax return, but maintain a spreadsheet tracking:
- • Inventory on hand (value of unsold products)
- • Accounts receivable (money owed to you)
- • Accounts payable (money you owe suppliers)
This manual reconciliation helps you see real profitability without IRS complexity. TrueCraft automates this hybrid tracking.
Real Example: Same Business, Two Methods
Let's look at Sarah's pottery business in December:
| Transaction | Cash Basis | Accrual Basis |
|---|---|---|
| Dec 1: Buy $2,000 clay (pay cash) | -$2,000 | $0 (asset) |
| Dec 15: Ship $5,000 wholesale order | $0 (not paid yet) | +$5,000 |
| Dec 20: Receive $3,000 from Nov orders | +$3,000 | $0 (already counted) |
| Dec 31: Use $1,000 of clay for production | $0 (paid earlier) | -$1,000 |
| December Net Profit | +$1,000 | +$4,000 |
Analysis: Sarah's cash basis shows $1,000 profit (received $3k, spent $2k). Her accrual basis shows $4,000 profit (earned $5k, consumed $1k materials). Accrual reflects her true economic performance—she created $4k in value. Cash basis makes it look like she barely broke even.
How to Switch Methods (If You Need To)
You can't casually switch accounting methods. The IRS requires you to file Form 3115 (Application for Change in Accounting Method) and explain why you're switching.
Valid Reasons to Switch:
- ✓ Business growth (now carrying inventory, need accrual)
- ✓ Seeking bank financing (lender requires accrual statements)
- ✓ Tax optimization (CPAs often recommend accrual for inventory-heavy businesses)
- ✓ Simplification (scaling down, want to move back to cash)
Important: Switching creates a one-time tax adjustment to prevent double-counting income/expenses. Work with a CPA to calculate this "Section 481(a) adjustment."
TrueCraft's Approach: Best of Both Worlds
TrueCraft tracks your business using modified cash basis by default—you get tax simplicity with operational visibility:
- Tax reporting: Cash basis (simple, IRS-friendly)
- Profitability dashboard: Accrual-adjusted metrics (shows true profit)
- Inventory tracking: Real-time valuation (see what you have on hand)
- Cash flow forecasting: Separate from profitability (know when money arrives)
When tax season arrives, export cash-basis reports for your CPA. For daily operations, use accrual-informed dashboards to make profitable decisions. No manual reconciliation required.
Resources
IRS Form 3115: Application for Change in Accounting Method - Official IRS form and instructions for changing your accounting method from cash to accrual or vice versa.
SBA Accounting & Bookkeeping Guide - Federal guidance on choosing and implementing accounting methods for small businesses.
AICPA Small Business Resources - American Institute of Certified Public Accountants resources on accounting standards and best practices.
SCORE Mentoring: Free Business Mentors - Connect with volunteer business experts who can review your accounting method choice.
Stop Choosing Between Simplicity and Accuracy
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