TL;DR
Most agencies choose cash accounting for tax simplicity, but as the business scales, many find themselves transitioning to accrual accounting for improved visibility, easier access to financing, and strategic decision-making. Key takeaways:
- Cash accounting records revenue when collected and expenses when paid, offering simplicity and natural tax deferral—but agencies exceeding the IRS gross receipts threshold (inflation-adjusted annually under IRC §448) must generally use accrual accounting, subject to entity-type restrictions.
- Accrual accounting matches revenue to the period it's earned regardless of payment timing, providing clearer visibility into profitability—and is often required by lenders, investors, and acquirers regardless of your tax method.
- Your tax accounting method and your financial reporting method don't have to match—sophisticated agencies often maintain cash books for tax while using accrual internally for management decisions and external financing.
Most agency owners pick an accounting method when they incorporate and never think about it again. That works fine until you're staring at a tax bill on $50,000 you haven't collected yet—or a lender asks for accrual financials you don't have.
The gap between cash and accrual accounting shapes when you recognize revenue, when you deduct expenses, and how much you owe the IRS each year. For agencies juggling retainers, project invoices, and unpredictable client payment cycles, that timing matters.
What's less obvious: your tax accounting method and your financial reporting method are separate decisions. Many growing agencies use cash for tax purposes while maintaining accrual books for internal management, bank covenants, or investor reporting.
What's the Difference Between Cash & Accrual Accounting?
Cash basis accounting records revenue when money hits your bank account and expenses when you pay them. Invoice a client $20,000 in December, get paid in January—that's January revenue.
Accrual basis accounting records revenue when earned and expenses when incurred, regardless of when cash changes hands. That same December invoice counts as December revenue even if payment arrives months later.
| Transaction |
Cash Basis |
Accrual Basis |
| December invoice sent ($20,000) |
Not recorded |
$20,000 revenue in December |
| January payment received |
$20,000 revenue in January |
No new entry |
Under cash accounting, you only pay taxes on money you've actually received. Under accrual, you might owe taxes on invoices your clients haven't paid yet.
The IRS Threshold: When You Lose the Choice
Under IRC §448, businesses with average annual gross receipts exceeding the small business threshold over the prior three tax years must use accrual accounting. This threshold is inflation-adjusted annually (it's currently $32million for 2026) and comes with entity-type restrictions for certain C corporations, partnerships with C corporation partners, and tax shelters.
The majority of agencies never reach this level of revenue, which allows the flexibility to pick and choose the method that's the best fit for your individual situation.
But for larger agencies approaching the threshold, transition timing matters. Switching from cash to accrual mid-growth creates a one-time tax hit as you recognize all outstanding receivables. Planning before you're forced gives you more control.
Tax Books vs. Financial Reporting: They Don't Have to Match
Your tax accounting method and financial reporting method are independent decisions.
Lenders often require accrual financials. Banks evaluating lines of credit or SBA loans want to see revenue when earned, not when collected.
Investors and acquirers expect GAAP-compliant statements. Accepting outside investment from institutional sources, or being acquired, will both typically trigger a due diligence process that requires accrual-based financials.
Internal management benefits from accrual visibility. Understanding client profitability and project margins requires matching revenue to the work that generated it.
Many sophisticated agencies maintain dual books: cash basis for tax filings and accrual basis for internal dashboards, lender reporting, and strategic planning.
💡 Key Insight: Your tax method optimizes for IRS obligations. Your financial reporting method optimizes for operational clarity and external requirements. Treating them as the same decision limits your options.
Which Method Fits Your Agency?
Retainer-heavy agencies: Cash and accrual align closely when payment timing matches service delivery. The operational complexity of dual books may not justify the benefit.
Project-based agencies: Milestone billing creates gaps between work delivery and payment. Accrual provides clearer project profitability; cash shows losses followed by windfalls.
Agencies with significant receivables: If AR regularly exceeds 30-45 days of revenue, cash accounting helps you avoid paying taxes on money you haven't collected.
You're probably ready for accrual (at least for financial reporting) if:
- You're seeking or maintaining a line of credit
- You're evaluating acquisition or investor interest
- Your billing cycles create significant timing gaps
- You need clearer visibility into client profitability
Tax Planning Considerations
As we noted earlier, the choice of accounting method can also have a significant impact on your tax planning. Here's a quick breakdown:
Cash basis strategies: Accelerate expenses by paying vendor bills before December 31—software subscriptions, contractor payments, performance bonuses. Income deferral is more limited due to constructive receipt rules: if you've earned income and have an unrestricted right to receive it, delaying the invoice may not defer recognition.
Accrual basis strategies: Bad debt deductions become available when you write off uncollectible receivables you've already recognized as revenue. Under cash accounting, you never recorded the revenue—nothing to write off.
Agency-specific considerations: Media pass-through billing creates timing questions under both methods. Year-end contractor payments are deductible when paid (cash) or when the obligation becomes fixed (accrual).
💡 Key Insight: Cash accounting offers more direct tax timing control. Accrual accounting creates different planning opportunities around revenue recognition and bad debt. Both require understanding the rules that limit aggressive positions.
How to Switch from Cash Accounting to Accrual Accounting
Switching methods requires IRS approval through Form 3115. Moving from cash to accrual accelerates income recognition—outstanding receivables become immediately taxable, though the IRS generally allows spreading the adjustment over four years.
If you're approaching the gross receipts threshold or anticipating a financing event requiring accrual financials, start the evaluation 12-18 months ahead. Rushed transitions create unnecessary tax exposure.
If you're going to adopt accrual accounting, it's likely you'll need additional financial support to do so. At Iota Finance, we work with several agencies to manage their accrual accounting through our outsourced accounting and bookkeeping services – get in touch if that's something you feel you could benefit from.
Build an Accounting Foundation That Supports Growth
Cash accounting serves many agencies well for tax purposes, particularly in earlier stages. Accrual provides the visibility and credibility that scaling agencies need for management decisions, lender relationships, and strategic transactions.
At Iota Finance, we help agencies build financial systems that match how they actually operate—including dual-book infrastructure when that serves your strategic needs. Whether you're evaluating cash versus accrual, preparing for a method change, or building toward a financing event, we provide the accounting and advisory support growing agencies need.
Schedule a discovery call to discuss which accounting approach fits your agency.