The cash method. The cash method is the more commonly used method of accounting in small business. Under the cash method, income is not counted until cash (or a check) is actually received, and expenses are not counted until they are actually paid.
The accrual method. Under the accrual method, transactions are counted when the order is made, the item is delivered, or the services occur, regardless of when the money for them (receivables) is actually received or paid. In other words, income is counted when the sale occurs, and expenses are counted when you receive the goods or services. You don't have to wait until you see the money, or actually pay money out of your checking account, to record a transaction.
Choosing an Accounting Method
When you can choose either method. Most small businesses (with sales of less than $5 million per year) are free to adopt either accounting method.
When you must use the accrual method. You must use the accrual method if:
your business has sales of more than $5 million per year, or
your business stocks an inventory of items that you will sell to the
public and your gross receipts are over $1 million per year. Inventory
includes any merchandise you sell, as well as supplies that will
physically become part of an item intended for sale.
Whichever method you use, it's important to realize that either one gives you only a partial picture of the financial status of your business.