Cash basis vs accrual accounting – what’s the difference?
3-minute read
As a small business owner you might be wondering which accounting method to use: accrual accounting or cash basis accounting.
You'll need to manage your books, not only for tracking your profits and filing your tax return, but understanding business performance, making budgeting decisions, and applying for loans and investment.
The method you choose depends on your business setup and how complex your operations are. But deciding whether to use accrual accounting or cash basis needn’t be tricky – find out what you need to know here.
What is accrual accounting?
Accrual accounting is a way to record your income and expenses based on the date of an invoice or bill, rather than the date the money changes hands.
Also known as traditional accounting, accrual accounting means you’re accounting for expected income and expenses within that accounting period even if you’ve not yet been paid.
Accrual accounting is useful if you’re applying for finance or planning to sell your business as it gives investors an accurate picture of your business’s financial position. It can also give you a better idea of cash flow and general business performance.
What is cash basis accounting?
Cash accounting (or cash basis accounting) lets you do your taxes based on when money actually comes in (and leaves) your business. You’ll record the date you make or receive a payment rather than the date of your invoice or bill.
Small businesses might find that cash basis accounting is a more straightforward way to manage their finances than traditional accounting.
Sole traders and partnerships can use cash basis accounting, which is particularly suited to businesses that don’t have a complicated setup.
Here’s a cash accounting example for income…
- you complete a job in February 2023, but unfortunately don’t get paid until 12 April 2023
- while you did the work in the 2022-23 tax year, you didn’t get paid until 2023-24
- the money counts as income for 2022-23, meaning it doesn’t go on your next tax return
…and a cash basis accounting example for expenses:
- you bought 10 items of stock to sell in your shop in August 2022, but still had two items left by 6 April 2023
- as you paid in August 2023, all 10 items count as an expense for tax year 2023-24
- there’s no stock asset left at year end
Can my small business use cash basis accounting?
There are rules about who can and can’t use cash basis accounting. You have to:
- be a self-employed sole trader or partnership running a small business
- have a turnover of £150,000 or less a year
If you have more than one business, you have to use cash basis accounting for all of them – and you can’t earn more than a combined turnover of £150,000.
And what if your business is doing well and makes more money throughout the year? You can stay in the scheme up to a turnover of £300,000 a year – after which you’ll need to use traditional accounting for your next tax return.
However, the rules are changing from April 2024. It was announced in the Autumn Statement 2023 that cash basis accounting will be the default method for all small businesses, and the thresholds based on turnover will be removed. Read more about the changes on the Government website.
Meanwhile VAT-registered businesses…
- can use cash accounting as long as turnover is no more than £150,000 a year
- must record VAT payments made to HMRC as expenses
- must record VAT repayments from HMRC as income
Limited companies and limited liability partnerships can’t use cash basis accounting, and HMRC has a list of other types of businesses that can’t join (these are niche, though, including waste disposal and ministers of religion).
Cash basis vs traditional accounting
Cash basis is simpler than traditional accounting, because you don’t need to keep other records on top of your income and expenses.
Whereas businesses using accrual accounting need to show:
- what you’re owed but haven’t received yet
- expenses you haven’t paid yet
- the value of stock and work in progress at the end of your accounting period
- year-end bank balances
- how much you’ve invested in the business over the year
- money taken out for personal use
Read more about tax records and how long you need to keep them.
The UK government website calls out a number of reasons why cash basis accounting might not suit your business, for example if you:
- want to claim interest or bank charges of more than £500 as a business expense (you can’t claim more than this using cash basis)
- have a complicated setup (if you have lots of stock, for example)
- are looking for finance – a bank might ask to see what you’re owed and are due using traditional accounting
- have losses you want to offset against other taxable income (sideways loss relief – offsetting losses against another business you run)
This means that cash basis accounting is ideal for simpler, smaller businesses that aren’t owed a lot of money (and don’t owe a lot of money).
Ultimately deciding between traditional accounting or cash basis depends on your setup, so it’s best to speak to a professional accountant or legal adviser if you’re not sure.
Summary of cash vs accrual accounting
Cash accounting | Accrual accounting | More info | |
|---|---|---|---|
Business type | Sole traders or partners VAT-registered businesses (if income is £150,000 or less in the tax year) | Larger or complex businesses Limited companies Liability partnerships | How to register as self-employed and choose a business structure |
Turnover | £150,000 or less a year | More than £150,000 a year | |
Pros | Simpler accounting records, useful for very small businesses and the self-employed | Full view of debt and income, may be needed to comply with business accounting regulations or apply for finance | |
Cons | Shows limited picture of business finance and cash flow Possible to switch accounting methods later, but can be tricky | More complex accounting method as includes pending transactions, so can be confusing when to record them |
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Written by
Catriona Smith
Catriona Smith is a content and marketing professional with 12 years’ experience across the financial services, higher education, and insurance sectors. She’s also a trained NCTJ Gold Standard journalist. As a Senior Copywriter at Simply Business, Catriona has in-depth knowledge of small business concerns and specialises in tax, marketing, and business operations. Catriona lives in the seaside city of Brighton where she’s also a freelance yoga teacher.
We create this content for general information purposes and it should not be taken as advice. Always take professional advice. Read our full disclaimer
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