Cash Basis vs Accrual Accounting: Which Is Right for Your Business?

At a Glance

• Cash basis records income when received and expenses when paid — simpler, suited to most small businesses
• Accrual accounting records income when earned and expenses when incurred — more accurate, required for limited companies
• From April 2024, cash basis is the default for eligible sole traders and partnerships
• There is no longer a turnover threshold for cash basis — the old £150,000 limit was removed
• Limited companies must use accrual accounting — they cannot use cash basis
• You can switch between methods, but the best time to do so is at the start of a new tax year

What Is the Difference?

The key difference between cash accounting and accrual accounting is timing — when you record income and expenses in your books.

Cash basis accounting: You record income when money actually arrives in your bank account. You record expenses when money actually leaves your account. It is exactly like tracking your personal bank balance.

Accrual accounting: You record income when you earn it — usually when you send an invoice, not when you get paid. You record expenses when you incur them — usually when you receive a bill, not when you pay it.

A simple example:

You complete a project for a client in March and send an invoice for £2,000. The client pays in April. You also receive a supplier’s bill in March for £500 but pay it in April.

Under cash basis, the £2,000 income appears in April’s books and the £500 expense appears in April’s books. March shows neither.

Under accrual accounting, both the £2,000 income and the £500 expense appear in March’s books, because that is when they were earned and incurred.

Neither method is ‘correct’ or ‘incorrect’. They are measuring different things. Cash basis shows your actual cash position. Accrual accounting shows your business’s financial performance more accurately because it includes money you are owed and bills you need to pay.

Who Uses Which Method?

Your business structure determines which method you can use:

Advantages and Disadvantages

Cash Basis Advantages:

• Simpler to understand and manage — no need to track debtors and creditors
• You only pay tax on money you have actually received
• Better for cash flow — you are not paying tax on income you have not collected yet
• Fewer records to keep — no need to track unpaid invoices or upcoming bills
• Works well with simple spreadsheet bookkeeping

Cash Basis Disadvantages:

• Can give a misleading picture if you have lots of unpaid invoices or upcoming bills
• Not suitable if you need detailed financial reports (e.g., for investors or lenders)
• Some businesses find it harder to spot trends when income and expenses are recorded based on payment timing rather than when the work was done

Accrual Accounting Advantages:

• More accurate picture of your business’s financial health
• Required for limited companies and often expected by lenders and investors
• Helps you see trends because income and expenses are matched to the period they relate to
• Better for businesses with stock or work-in-progress

Accrual Accounting Disadvantages:

• More complex — you need to track accounts receivable, accounts payable, prepayments, and accruals
• You might pay tax on income before you have received it
• Usually requires accounting software or professional help
• More time-consuming

How to Switch from Cash Basis to Accrual

If you decide accrual accounting would suit your business better, the best time to switch is the start of a new tax year (6 April).

Step 1: Choose your start date. The beginning of a tax year keeps things clean.

Step 2: Record what you are owed. List all unpaid invoices you have sent to customers. These become your ‘accounts receivable’ opening balance.

Step 3: Record what you owe. List all unpaid bills you have received from suppliers. These become your ‘accounts payable’ opening balance.

Step 4: Record any stock. If you hold stock or work-in-progress, record its value as an asset at the switchover date.

Step 5: Adjust for prepayments. If you have paid in advance for anything — insurance, subscriptions, rent — record the unused portion as an asset.

Step 6: Tell HMRC. You do not need to contact them separately. Just indicate on your Self Assessment tax return that you are using traditional (accrual) accounting rather than cash basis.

Step 7: Update your software or spreadsheet. If you use accounting software, there is usually a setting to change your accounting method. If you use a spreadsheet, add columns for accounts receivable and accounts payable.

Warning: Switching can affect your tax bill in the transition year. Some income or expenses may be counted twice or not at all. If your accounts are complex, speak to an accountant before switching.