For growing construction companies, the decision to move from cash to accrual accounting often feels like an accounting technicality. But this transition represents a fundamental shift in how you understand your business, one that affects everything from daily cash flow management to your ability to secure financing and bonding.
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The Basic Difference: Cash Flow vs. Profitability
The fundamental distinction between cash and accrual accounting comes down to timing.
- Cash basis accounting records revenue when money hits your bank account and expenses when you pay them.
- Accrual accounting matches revenue with the expenses incurred to generate it, regardless of when cash changes hands.
These represent two fundamentally different perspectives on your business that often get confused: cash flow versus profitability. Understanding the distinction between them is critical for making sound business decisions.
In construction, this distinction becomes especially important because of how projects are structured. Many contractors front-load billing with general conditions and other items to help fund initial startup costs. On a cash basis, that upfront payment looks like immediate profit. But the reality is that you'll have expenses tied to that revenue for months to come.
That early billing helps get cash in the door, but it doesn't represent recognized revenue right away. Later in the project timeline, this creates a cash shortage as expenses continue but billing slows down.
The Blind Spots of Staying on Cash Basis
For contractors running longer-term projects—three months, six months, or more—cash basis accounting creates dangerous blind spots. When you bill heavily upfront, it's easy to subconsciously believe that money represents your margin on the job. But at the end of the project, you may have no income coming in while expenses continue.
On accrual accounting, you can see month-over-month how much you've built and the costs tied to that work. Without this visibility, you're operating without crucial decision-making information. While reviewing financials monthly is essential for any business owner, the information provided by cash basis books often lacks the usefulness needed for strategic decisions.
The problems compound when you're running multiple complex jobs simultaneously. You'll see peaks and valleys in your financials that don't reflect the actual health of your business, making it difficult to manage the tight profit margins typical in construction—often just 10-15%.
The Stakes: Banks, Investors, and Bonding Companies
The accounting method you use isn't just about internal management, it directly impacts your ability to access capital and grow.
Banks and bonding companies want to see accrual-based financials because they provide a clearer picture of your actual performance and future obligations. They need to understand your work in progress, your accounts receivable aging, and your true profitability trends—none of which are visible on cash basis statements.
Cash basis makes it difficult to demonstrate your true net worth. For contractors already competing against larger, more established companies, this creates an additional hurdle. Moving to accrual basis significantly improves your position when seeking financing or bonding capacity. It’s also a big factor if you’re considering selling your business or pursuing a merger. Potential buyers need predictable financial models to make acquisition decisions.
This can come as a surprise to many contractors who have operated successfully on cash basis for decades, consistently making money and building profitable businesses. When it comes time to sell, they discover that potential buyers have little interest in working with their financials. Without accrual-based records, buyers can't create the predictable models they need to make acquisition decisions.
The painful reality? When companies finally decide to pursue these opportunities, they often have to pay to have two to three years of financials completely redone—an expensive and time-consuming process that could have been avoided with proper planning.
When Should You Make the Switch?
While the IRS has requirements for when companies must switch to accrual accounting, waiting until you're forced to is a mistake. The transition typically makes sense around $10-15 million in revenue, which is sooner than most contractors make the move.
But it's not always about revenue. The real trigger is complexity. Short-term jobs that last around 30 days don't create significant issues on cash basis. But once projects extend to three to six months, and you're managing three or four simultaneously, the financial peaks and valleys become problematic.
For some contractors, the switch makes sense around $7 million if they're running complex, long-duration projects. The key is evaluating your project types, durations, and the number of simultaneous jobs you're managing.
Why It Matters for Taxes (And Why You Might File Both Ways)
Here's where it gets interesting: even when you should be evaluating your business on an accrual basis, you may not want to file your taxes that way.
When you're not required to use percent complete or accrual-based accounting for tax purposes, maintaining cash basis for tax filing can offer significant advantages.
The reason comes down to timing. If you have drawn-out jobs or work with clients who take 30, 60, or even 90 days to pay, you could end up recognizing significant revenue on your tax return at year-end—revenue you haven't actually collected yet. That means paying taxes on money you don't have in hand.
The solution is to maintain both methods simultaneously. File taxes on a cash basis while using accrual accounting for internal management decisions. This allows you to track actual month-to-month profitability while optimizing your tax position.
This approach requires coordination with your CPA and an accounting system that can toggle between cash and accrual. At year-end, you create financial statements on a cash basis for tax filing while using accrual throughout the year for management decisions.
Preparing for a Smooth Transition to Accrual Accounting
If you're approaching the point where it makes sense to switch over to accrual accounting, here's how you can start preparing now:
- Clean up your job costing. You can't make accrual work without proper job costing. If you're dumping everything into corporate revenue accounts without tracking individual projects, you'll need to fix that first.
- Evaluate your accounting system. Not every system can handle the requirements of accrual accounting in construction. You need construction accounting software that manages change orders, project management, AP/AR, billing, and draw requests in one platform—without requiring a complex web of API integrations that create data integrity issues.
- Build your WIP schedule. Start tracking your work in progress schedule monthly, even if you're not making formal accrual adjusting entries yet. It's much easier to add new jobs to an existing schedule than to recreate everything when you're ready to switch.
- Coordinate with your CPA. If you're making the transition for tax purposes, you need to notify the IRS and file specific forms. You can't simply switch methods without proper documentation.
Think two to three years ahead. Are you going to need a loan? Want to sell? Considering a merger? Whatever you start now is what lenders and buyers will review in the future. The time to get your financials in order isn't when you need them, it's well before. Starting proper accounting practices today means creating records that will be valuable years down the road when opportunities arise.
The Bottom Line
The transition from cash to accrual accounting isn't just an accounting exercise—it's about gaining visibility into your business, making better decisions, and positioning your company for growth. Whether you're pursuing bonding capacity, seeking acquisition, or simply trying to understand if your projects are actually profitable, accrual-based financials provide the clarity that cash basis statements simply cannot.
The question isn't whether to make the switch, but when—and for most growing contractors, the answer is sooner than you think.
Need help making the switch to accrual accounting? Charlie and his team can help. Reach out today.