There are actually two questions buried in this one. What method does the IRS require for your tax return, and what method makes sense for running the business. They don’t have to be the same answer.

On the tax side, the IRS allows small contractors to use cash basis if your average annual gross receipts over the prior three years are under roughly $29 million (the threshold adjusts for inflation, currently $30 million for 2024 returns). Below that threshold, you can file taxes on cash basis and skip the long-term contract rules. Above it, you’re required to use the percentage-of-completion method on contracts that span more than one tax year. There are exceptions for home construction contractors and a few other categories, but the general rule holds for most commercial builders and larger residential contractors.

Cash basis is simpler. You recognize revenue when money hits your account and expenses when you pay them. Your bookkeeper can keep up with it. Your tax return is easier to prepare. If you’re a small remodeler or trade contractor doing short-duration jobs, cash basis often reflects reality well enough.

The problem with cash basis on longer projects is that it hides what’s actually happening. You might collect a large draw in January on a job that won’t be finished until June, with most of the costs still ahead of you. Your books show a huge profit that month and losses later. You can’t tell which jobs are making money and which are bleeding. You can’t price new work intelligently because you don’t know your true margins on completed jobs.

Percentage-of-completion recognizes revenue as the work gets done, matched against the costs incurred to do it. A job that’s 40% complete by cost shows 40% of the contract revenue on your books. This is what proper job costing supports, and it tells you whether each project is actually profitable while you still have time to do something about it.

The other factor is who reads your financials. Bonding companies want accrual. Banks want accrual, especially for any meaningful line of credit or project financing. Sophisticated investors and partners want accrual. Cash basis statements don’t give them the picture they need to underwrite risk, and trying to hand them cash basis books when they’ve asked for accrual is how deals stall out.

What many construction companies do is run accrual internally for management reporting and outside stakeholders, then convert to cash basis at year end for the tax return if they qualify. The conversion work is real but manageable when the books are set up correctly from the start. If you’re thinking about bonding, bringing in a partner, or pursuing bank financing, set up accrual from day one even if you’re under the threshold.

The right answer depends on your size, your project durations, and who you need to show financials to. Small trade shops doing same-week work stay on cash. Anyone running projects that cross months or wanting to scale into bonded work should be on accrual regardless of what the tax code permits. If you want to walk through where your business falls, the Pasadena bookkeepers at A Squared can help you think through the trade-offs and set up books that serve both purposes.