Making a cash to accrual conversion isn't just about following IRS rules—it's one of the most strategic financial decisions your business will make.
While most businesses start with cash basis accounting for its simplicity, the right accounting method can unlock funding opportunities, optimize your tax strategy, and position your company for sustainable growth.
Whether you're approaching the mandatory revenue thresholds, planning for investors, or simply want to get ahead of your financial strategy, understanding when and how to make this switch is critical. The decision you make today affects your business for the next five years (yes, there's a lock-in period), so getting it right matters.
In this article, we'll walk you through everything you need to know about cash to accrual conversion, from the strategic reasons companies make the switch to the exact steps involved in the process.
Plus, we'll share how to make this decision proactively rather than reactively, because the best time to plan your accounting method change is before you're forced into it.
Stay until the end to learn how to get help — because this finance stuff is hard!
What is Cash to Accrual Conversion?
Cash to accrual conversion is the process of changing your business's accounting method from recording transactions when money changes hands (cash basis) to recording them when they're earned or incurred (accrual basis).
Here's the key difference in simple terms:
- Cash basis accounting records revenue when you receive payment and expenses when you pay bills. If you invoice a client $5,000 in December but don't get paid until January, that revenue appears in January's books.
- Accrual accounting records revenue when you earn it and expenses when you incur them, regardless of payment timing. That same $5,000 invoice goes on December's books because that's when you completed the work.
This timing difference might seem minor, but it fundamentally changes how you understand your business's financial health, especially for companies with longer sales cycles, recurring revenue models, or significant accounts receivable.
Step-by-Step: How To Convert Cash to Accrual Accounting
Once you've decided to make the switch, here's exactly what the conversion process involves:
Step 1: Add Accrued Expenses
Start by identifying and recording all accrued expenses—money you owe but haven't yet paid:
- Utility bills received but not yet paid
- Vendor invoices sitting in your accounts payable
- Accrued payroll and benefits
- Interest on loans or credit lines
- Any other obligations incurred but not yet paid
Example: If you received a $500 electric bill on March 28th but won't pay it until April 5th, record it as an accrued expense in March.
Step 2: Subtract Cash Payments
When you pay those accrued expenses, remove them from your accrued expenses account and record the cash payment:
- Credit your cash account for the payment amount
- Debit your accrued expenses to show the obligation is satisfied
- This creates the double-entry that keeps your books balanced
Step 3: Add Prepaid Expenses
Record any expenses you've paid in advance:
- Prepaid rent or lease payments
- Insurance premiums paid annually
- Software subscriptions paid yearly
- Any other advance payments for future services
These are considered assets because they represent value you'll receive in the future.
Step 4: Add Accounts Receivable
Record all money owed to you by customers:
- Outstanding invoices sent to clients
- Completed work not yet billed
- Recurring revenue earned but not yet collected
- Any other money legitimately owed to your business
SaaS Example: If you have annual contracts, record the full year's revenue and show the unpaid portion as accounts receivable.
Step 5: Subtract Cash Receipts
When customers pay their invoices:
- Remove the amount from accounts receivable
- Add the cash to your cash account
- This shows the receivable has been converted to cash
Step 6: Subtract Customer Prepayments
Handle any money customers have paid you in advance:
- Customer deposits for future work
- Prepaid service contracts
- Any other advance payments from customers
These become liabilities because you owe the customer either the service or their money back.
Common Issues Converting From Cash to Accrual Accounting & How to Avoid Them
Making the change from cash accounting to accrual accounting isn’t an automatic process. The transition requires careful planning on many levels, from accounting software changes to balancing procedures.
Here's how to navigate them:
Challenge 1: Double-Entry Bookkeeping Complexity
The Problem: Cash accounting lets you record transactions once, but accrual requires double-entry bookkeeping for every transaction.
The Solution: Start with a clean trial balance and systematically work through each category. Consider using accounting software that handles double-entry automatically, or work with an experienced accounting team during the transition.
Challenge 2: Timing the Conversion
The Problem: You can't just flip a switch—the IRS requires proper documentation and timing.
The Solution: Plan your conversion for the beginning of your tax year. File Form 3115 during your first year using the new method. If you're required to switch due to revenue thresholds, you have specific deadlines to meet.
Challenge 3: Historical Data Adjustments
The Problem: Converting methods often requires restating previous periods to show accurate comparisons.
The Solution: Work with your accounting team to determine how much historical restatement is necessary. Some businesses need full prior-year adjustments, while others can use a more simplified approach.
Challenge 4: Software Limitations
The Problem: Many accounting software platforms don't seamlessly convert between methods.
The Solution: Understand your software's limitations before starting. QuickBooks, for example, has a "cash basis toggle" that doesn't provide true cash basis reporting. You may need to upgrade your software or work with an accountant who can handle the conversion properly.
Determine the Right Financial Strategy for Your Business
The key to successful cash to accrual conversion is thinking strategically, not reactively. Here's how to approach the decision:
Think Forward, Not Backward
Consider where your business will be in 2-3 years, not just today. Remember, you're locked into your choice for five years once you switch, so alignment with your future goals matters more than current convenience.
Consider All Three Dimensions
Evaluate your situation across all three factors:
- Compliance: Are you approaching mandatory thresholds?
- Tax Strategy: Could accrual (or dual-method) optimize your tax position?
- Business Strategy: Does accrual support your funding, growth, or exit plans?
Professional Assessment
Given the complexity and long-term implications, most businesses benefit from professional guidance. An experienced accounting team can analyze your specific situation across compliance, tax optimization, and strategic objectives.
Frequently Asked Questions
When are you required to switch to accrual accounting?
The IRS requires accrual accounting for businesses with gross receipts exceeding $29 million (2024) or $31 million (2025), and for most inventory-based businesses. Nonprofits also need accrual accounting for GAAP-compliant audited financial statements.
How long does cash to accrual conversion take?
The actual conversion process typically takes 10-20 hours of accounting work, depending on your business complexity. However, planning and decision-making should start months before your target switch date.
What forms do I need to file with the IRS?
You must file Form 3115 (Application for Change in Accounting Method) during the first year you use accrual accounting. This form requires detailed financial information and specific calculations.
Can I switch back to cash basis accounting?
Generally, no. The IRS requires a legitimate business purpose for accounting method changes and typically won't approve switches back to cash basis, especially if you were required to use accrual method.
What's the difference between changing your books and changing for tax purposes?
Some businesses maintain accrual-basis books for better business insights while filing cash-basis tax returns. This dual approach provides flexibility but requires maintaining essentially two sets of records.
Get Expert Financial Support With Your Cash to Accrual Conversion
Converting from cash to accrual accounting isn't just about compliance—it's a strategic business decision that affects your company's growth trajectory, tax efficiency, and future opportunities. The right approach requires careful analysis of your compliance
Our team specializes in helping nonprofits, agencies, and small businesses navigate complex financial transitions while optimizing for growth. We handle everything from the technical conversion process to Form 3115 filing, ensuring your transition is smooth and strategically sound.
Ready to make a strategic decision about your accounting method?
Contact us today to schedule a consultation and discover how the right accounting approach can support your business goals.
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