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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.
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.
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…
…and a cash basis accounting example for expenses:
There are rules about who can and can’t use cash basis accounting. You have to:
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…
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 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:
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:
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.
Sole traders or partners
VAT-registered businesses (if income is £150,000 or less in the tax year)
Larger or complex businesses
£150,000 or less a year
More than £150,000 a year
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
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
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.
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