Two Ways to Count: Choosing Between Cash Basis and Accruals for Your Business

Most small business owners give little thought to how their accounts are prepared — only to the figures that emerge at the end. Yet the method behind those figures matters more than many realise. Choose wisely and your cash flow, tax bill and admin burden all become easier to manage. Choose carelessly and you may find yourself paying tax on money you have not yet received.

There are two broad approaches used in the UK: the cash basis and accruals accounting. This article explains the difference, sets out who qualifies for each, and works through three common scenarios so you can see which fits your circumstances.

The Core Difference, In Plain Terms

Under accruals accounting (sometimes called traditional accounting), you record income when you invoice it and expenses when you incur them — regardless of when money actually changes hands. A £5,000 invoice raised in March counts as March income even if the client does not pay until June.

Under the cash basis, you record income only when it actually lands in your bank account, and expenses only when you actually pay them. That same £5,000 invoice counts as income in June, when the payment arrives.

For businesses with slow-paying customers, the cash basis can defer tax comfortably. For businesses that collect payment immediately, the difference is often minimal.

Who Can Use the Cash Basis?

The cash basis is available to unincorporated businesses — sole traders and partnerships — with turnover of £300,000 or less (a threshold that rose from £150,000). Most sole traders now default onto the cash basis unless they actively opt out.

Limited companies, by contrast, must generally use accruals accounting for their statutory accounts. There are narrow simplifications available, but if you have gone through the incorporation question, you have effectively committed to accruals.

Three Worked Examples

The Freelance Designer (Sole Trader)

Priya is a freelance designer invoicing larger agencies, which typically pay in 60 days. Near the end of the tax year she raises several invoices that will not be paid until after 5 April.

Under accruals, those invoices count as this year's income and the tax falls due sooner. Under the cash basis, they belong to next year's figures instead. For Priya, the cash basis smooths her cash flow and defers tax on work she has not yet been paid for — a sensible fit.

Verdict: cash basis works well.

The Shop Owner (Sole Trader)

Marcus runs a village shop. Customers pay on the spot, so there is little difference between invoiced income and received income. However, he buys stock in bulk and holds significant inventory.

The cash basis treats stock purchases as an expense only when paid — but it does not allow you to account for changes in stock values in the same way accruals does. For a business where stock levels fluctuate materially, accruals can give a truer picture of profit and, in some years, a lower tax bill.

Verdict: accruals is likely the better fit, despite the extra bookkeeping.

The Growing Limited Company

Elena runs a marketing agency that incorporated two years ago. As a company, accruals accounting applies. Her accounts must match income and expenses to the period they relate to, including debtor and creditor balances, and her year-end accounts feed into Corporation Tax.

This is more work than the cash basis, but it gives lenders, investors and Companies House a consistent, comparable picture — and it is what the rules require.

Verdict: accruals, by necessity and by merit.

Switching Methods: Proceed With Care

Sole traders can generally move between the two methods, but timing matters. Switching from accruals to cash basis requires care with debts owed to and by the business at the transition date, so that income is not double-counted or lost altogether. Getting this wrong is one of the more common (and avoidable) errors we see.

It is also worth noting that the cash basis has limits on interest and relief rules that do not apply under accruals — for example, interest paid is treated differently. If your finances are anything beyond straightforward, take advice before switching.

A Short Checklist

• Do customers pay you slowly? The cash basis may help your cash flow.
• Do you hold significant stock? Accruals may reflect profit more accurately.
• Are you a limited company? Accruals applies.
• Are you planning to incorporate or seek finance? Accruals figures will be expected.

The Bottom Line

Neither method is universally better. The right choice depends on how your business actually earns and spends money — and that is precisely where a conversation with your accountant earns its keep. If you are unsure which basis you are currently on, or whether a switch would help, do get in touch before the tax year runs away from you.