If you’re a custom home builder or contractor, you’ve probably heard your bookkeeper or CPA mention “cash basis” and “accrual basis” accounting. If your eyes glazed over at that moment, don’t worry, you’re not alone. Let’s break it down in plain English, using real examples from the construction world. Understanding the difference can help you make better decisions, price your jobs smarter, and avoid surprises that could have been avoided.
What’s Cash Basis?
Cash basis means you recognize income when customer payments are received, and you recognize expenses when you pay the bill or expense.
Example: You invoice a client $50,000 for a framing job in June, but they don’t pay you until August. Under Cash basis, you don’t count that income until August, when your customer pays you.
The same principle applies to expenses. Let’s say you received a bill for $10,000 of lumber delivered in June, but you didn’t pay the supplier until July. With cash basis, the expense shows up in July because that is when you paid the bill.
What are the advantages of cash basis? First, it’s simpler to track; you just follow the activity in your bank account. Cash basis is often used for tax filing by small construction businesses. It also keeps things straightforward for cash flow.
There is one catch. Cash basis can give you a skewed picture of how your jobs are performing, especially if you’re fronting material or labor costs long before a client pays you. Often, construction companies purchase materials and other costs up front. Even if you invoice in the same month you buy the project expenses, if the payment is received in the next month, your project may look less profitable than it actually is.
What is Accrual Basis?
Accrual basis means you recognize income when it’s earned and expenses when they’re incurred, not necessarily when cash moves.
Example: You invoice a client $50,000 for a framing job in June, but they don’t pay you until August. (same example as above) Under accrual basis, you recognize the income in June, when the work was completed and billed, even if the payment doesn’t come until August.
Expenses receive the same treatment again. If you ordered and received lumber in June, you recognize the $10,000 expense in June, even if you don’t pay the bill until July.
Why would a construction company want to use accrual basis? Accrual basis gives a more accurate picture of job profitability. It matches revenue to the related costs. Accrual basis is also useful for progress billing, job costing, and tracking Work in Progress (WIP). One downside is that it can be more complex than cash basis, which can be confusing if you are used to only watching your bank balance.
Which One Should You Use?
Many contractors choose cash basis for tax filing because it’s simpler and can help defer taxes. But that doesn’t mean you should run your business only on cash basis reports. Even if you file taxes on cash basis, it’s worth reviewing your books in both cash and accrual basis.
This is especially true when you’re looking at:
- Job profitability
- Overhead vs. direct costs
- Unbilled work or outstanding invoices
- How much you’ve earned but haven’t been paid yet
Why Review Both?
Here is a realistic scenario:
Let’s say you have $100,000 in the bank. Things look good.
But you’ve just finished three jobs, and you owe your subs $70,000 next week. You have a bill from your lumber supplier for $40,000 due later this week. Meanwhile, you’ve only collected $30,000 from your clients, and the rest is tied up in unpaid invoices.
Cash basis says: “You’re profitable!”
Accrual basis says: “You’re in the red until those clients pay you.”
See the difference?
As a home builder or contractor, you need more than just your tax reports to run a healthy business. Cash basis reporting shows you what has happened with your cash, but accrual basis tells you how your business is really performing.
Our recommendation: Use Cash basis for taxes. Use accrual basis for smart decisions.
If you’re not sure how to look at both, talk to your bookkeeper. A good one will help you toggle between both views so you can bid jobs more accurately, plan cash flow better, and sleep easier at night. Need help figuring this out for your construction business? Visit our Services page to see if our firm might be a good fit for your business needs.