Cash basis vs accrual accounting: which one a small business in India should use

Cash basis records a sale when the money reaches you and an expense when you pay it. Accrual basis (called the mercantile system in Indian tax law) records a sale when you raise the invoice and an expense when you receive the bill, whether or not cash has moved. Section 145 of the Income Tax Act allows either for business, profession and other-sources income if you follow it consistently; companies must use accrual, and GST always works on accrual.

The two methods in one sentence each

Under the cash basis, the question for every entry is "did money move?" Income is income when it lands in your bank or till; an expense is an expense when it leaves. Nothing is recorded for invoices raised but unpaid, or bills received but not yet paid.

Under the accrual basis, the question is "has the right or the obligation been created?" You earned the income when you delivered the goods or finished the service and raised the invoice, so it is recorded then, and the unpaid amount sits as a debtor. You owe the supplier the moment their bill arrives, so the expense is recorded then, and the unpaid amount sits as a creditor. Stock you bought but have not sold is an asset, not an expense. Rent for March that you pay in April still belongs to March.

The difference sounds academic until you see the same year through both lenses.

A worked example: Pune freelance designer

Riya runs a two-person design studio in Pune. Her FY 2026-27 looks like this:

• Invoices raised during the year: ₹24,00,000 (all for services, GST charged separately).
• Of these, invoices worth ₹4,50,000 were raised in February and March 2027 and were paid only in April and May 2027.
• Receipts during the year: ₹21,30,000, which includes ₹1,80,000 collected in April 2026 for invoices raised in March 2026 (last year's work).
• Expenses billed to her during the year: ₹9,60,000 (rent, software subscriptions, a freelance illustrator, internet, laptop repair, CA fee).
• Of these, the illustrator's March bill of ₹90,000 and the CA's year-end bill of ₹25,000 were paid in April 2027.
• Expenses paid during the year: ₹9,05,000, which includes ₹60,000 paid in April 2026 for last year's bills.

Same studio, same year, a ₹2,15,000 difference in profit. Neither number is wrong. The cash figure tells Riya what actually flowed through her account. The accrual figure tells her what she earned from the work done in the year, and it also shows her that ₹4,50,000 is stuck with clients, which the cash books simply do not mention.

Over several years the two methods converge, because every accrued invoice eventually becomes cash. What changes is which year each rupee is taxed in.

Who may use the cash basis under Section 145

Section 145(1) of the Income Tax Act says that income under "Profits and gains of business or profession" and "Income from other sources" shall be computed in accordance with either the cash or the mercantile system of accounting regularly employed by the assessee. A hybrid (cash for some items, accrual for others) has not been allowed since 1997.

In practice:

• Professionals (doctors, lawyers, architects, designers, consultants, freelancers) very commonly use cash basis. Fees are uncertain until received, there is no stock and few creditors, so cash books are both simpler and realistic.
• Traders and manufacturers almost always use accrual. If you hold stock and sell on credit, cash books misstate profit badly and cannot produce the balance sheet a bank asks for. Section 145(2) also lets the government notify Income Computation and Disclosure Standards (ICDS), which apply to those following the mercantile system and to all businesses for certain items such as valuation of inventory.
• Companies and LLPs must keep accrual books. Section 128(1) of the Companies Act, 2013 requires books "on accrual basis and according to the double entry system of accounting", and the LLP Act rules point the same way.
• Presumptive taxpayers under Section 44AD (businesses) or 44ADA (professionals) do not compute profit from books at all; a fixed percentage of turnover or gross receipts is deemed to be the profit. The method question mostly disappears, with one wrinkle: the lower 6% rate under 44AD applies to turnover received through banking or digital modes during the year or before the return due date, so receipts still matter. See the presumptive taxation guide.

Your ITR-3 asks which method you follow, and your CA reports it in Form 3CD if you are under tax audit. Pick one, state it, and keep it.

GST is always accrual: time of supply

Whatever your income tax books say, GST does not care whether you have been paid. Liability arises at the time of supply under Sections 12 (goods) and 13 (services) of the CGST Act.

For goods, the time of supply is the date of invoice (or the last date by which the invoice should have been issued, which is at or before removal or delivery). Since November 2017, advances received for goods do not trigger GST for regular taxpayers; only the invoice does. For services, the time of supply is the earlier of the invoice date (if issued within 30 days of the service) or the date of payment, so an advance for services does attract GST when received.

The consequences are the same in both cases. Riya's ₹4,50,000 of March invoices go into her March GSTR-1 and the 18% tax on them, ₹81,000, is paid in the GSTR-3B due on 20 April, even though the clients pay in May. On the other side, her input tax credit on the illustrator's March bill is available in March (subject to the Section 16 conditions and the bill appearing in GSTR-2B), and if she does not pay the illustrator within 180 days of the invoice she must reverse that credit with interest.

So even a cash-basis professional needs an accrual-style sales register for GST: every invoice, by date, regardless of payment. This is one reason to keep the invoice and the payment receipt as two separate documents; the invoice drives GST, the receipt drives your cash books. The GSTR-1 and GSTR-3B filing guide walks through the monthly cycle.

TDS behaves the same way. Your customer deducts TDS under Section 194J at the time of credit to your account or payment, whichever is earlier, so the deduction usually appears in Form 26AS in the month the invoice was booked by them, which may be a different year from the one in which you receive the money. Under Rule 37BA the credit for that TDS is allowed in the year the income is offered to tax, so a cash-basis professional who receives March fees in April must be careful to claim the TDS in the right year and not lose it.

How the choice changes profit and tax

The method changes the timing of income, and timing is tax. Three effects to understand:

Year-end bunching. Under accrual, a big March invoice is this year's income and this year's tax, paid by 31 July next year. Under cash, if the client pays in April, it slides into next year. Over time this evens out, but in a year when your income crosses a slab or a threshold (₹50 lakh for 44ADA, ₹1 crore for tax audit) the timing can matter.

Expenses you have not paid. Under accrual, the March bills you pay in April are still this year's deduction, provided the liability had crystallised. Under cash, they are next year's. Note that some expenses are on payment basis for everyone under Section 43B (GST, PF and ESI contributions, bonus, interest to banks, and since FY 2023-24, dues to micro and small enterprises under Section 43B(h)), so even accrual books lose the deduction until payment.

Bad debts. Under accrual, an unpaid invoice was counted as income, so when the customer defaults you write it off and claim a deduction under Section 36(1)(vii). Under cash basis it was never income, so there is nothing to write off, but you also paid tax only on what you actually received.

Advance tax is computed on the same basis as your books, so the method also decides how much you pay each 15 June, September, December and March. Check the advance tax due dates guide once you have settled your method.

Which method suits which business

If you are unsure, the honest test is this: if you cannot tell me your debtors and creditors on 31 March without looking them up, you are effectively on cash basis. If you need a bank limit, sell on credit, or hold stock worth more than a month's sales, move to accrual.

Switching from one method to the other

A change of method is allowed, but it must be a real, permanent change, and the transition year needs care so that nothing is taxed twice or never.

Suppose Riya moves from cash to accrual on 1 April 2027. On that date she brings in opening balances: debtors ₹4,50,000 (invoices raised but not received), creditors ₹1,15,000 (bills received but not paid), and any prepaid or outstanding expenses. The ₹4,50,000 she collects in April and May is then a receipt against those debtors, not fresh income, so it is not taxed again. But the ₹4,50,000 was also never taxed under cash basis in FY 2026-27, so it must be offered to tax somewhere. Her CA will typically include it in the transition-year computation so that income is neither doubled nor dropped. Document the reasoning in a note attached to the accounts.

Two more points. Section 145(3) lets the assessing officer reject books and estimate income if the method is not regularly followed or the accounts are incorrect or incomplete, so a switch that looks like a one-year tax dodge invites exactly that. And once you are on accrual, ICDS applies to you, which affects how you value stock, treat retention money and recognise revenue on long contracts. Take this step with your CA, not alone.

Common mistakes with cash and accrual books

Cash books for tax, accrual claims for GST, and never reconciling the two. The GST portal shows your invoiced turnover; your ITR shows receipts. A large unexplained gap between the two draws notices. Keep a reconciliation of invoiced versus received every year.

Mixing methods. Recording sales on accrual (because invoices are easy) but expenses on cash (because bills get lost) overstates profit and is not a permitted hybrid.

Forgetting closing stock on the cash basis. Even a cash-basis business that holds stock must value it at year end; otherwise this year's profit is understated and next year's overstated. Stock is never an expense until sold.

Treating advances as income under accrual. A customer's advance is a liability until you deliver. Under cash basis it is income when received. Know which rule you are under.

Claiming TDS in the wrong year. Cash-basis professionals often see TDS in Form 26AS for a year in which they have not offered the income, and either lose the credit or draw a mismatch notice. Rule 37BA lets you carry the credit to the year the income is offered; tell your CA.

Not recording debtors at all. If you are on cash basis, keep a separate outstanding statement anyway. Tax method is not an excuse to lose track of who owes you.

How VyaparKit helps

VyaparKit does not decide your accounting method, but it keeps the two streams that both methods need. Every GST invoice is dated and numbered, so your invoiced turnover for GST is a report rather than a reconstruction, and every payment receipt is recorded against the invoice, so your received turnover is equally clear. The customer ledger and outstanding statement with ageing give you the debtor figure you need for accrual books, or simply for chasing money if you stay on cash basis.

Next steps

• Write down which method you currently follow and check it matches what your last ITR said.
• Prepare a one-page reconciliation of invoices raised versus money received for the current year; the gap is your debtors.
• If you sell on credit or hold stock and are still on cash books, discuss a switch to accrual with your CA before 31 March.
• Keep the GST sales register on invoice date regardless of your income tax method.
• Read the bookkeeping basics guide for the weekly routine that keeps either method honest.