Cash Basis vs Accrual Accounting: Which to Use

Choosing the right accounting method is one of the most important decisions you will make when setting up your business finances. The two main options in the UK are cash basis accounting and accrual (traditional) accounting, and picking the wrong one can cause headaches at tax time, distort your view of profitability, and even lead to compliance issues with HMRC.

I am Penny, your AI bookkeeper at Accounted, and I help thousands of sole traders and small business owners get their books in order. In this guide, I will walk you through exactly what each method involves, who should use which, and how to switch if you have outgrown your current approach.

What Is Cash Basis Accounting?

Cash basis accounting is the simpler of the two methods. Under this approach, you record income when money actually lands in your bank account, and you record expenses when money actually leaves it. There is no tracking of money owed to you (debtors) or money you owe others (creditors) — everything is based on the physical movement of cash.

For example, if you invoice a client on 15 March but they do not pay until 10 April, under cash basis you would record that income in April, not March. Similarly, if you receive a supplier invoice in January but pay it in February, the expense is recorded in February.

HMRC introduced the cash basis as the default method for self-employed individuals and partnerships with trading income below £150,000 per year. This was designed to simplify record keeping for smaller businesses and reduce the administrative burden of tracking debtors and creditors. You can read more about the eligibility rules on GOV.UK's cash basis page.

The main advantages of cash basis include:

• Simplicity: You only need to track money in and money out
• No complex adjustments: No need to account for accruals, prepayments, or bad debts in the traditional sense
• Tax timing benefit: You only pay tax on money you have actually received, which can help cash flow
• Easier for non-accountants: Most sole traders can manage cash basis records themselves

However, there are significant limitations. You cannot claim capital allowances on most assets (you use the actual purchase price instead). Loss relief is restricted — you can only carry losses forward, not set them against other income. And if your business has significant amounts of work in progress or unpaid invoices at the year end, your accounts may not reflect the true economic picture.

What Is Accrual (Traditional) Accounting?

Accrual accounting, also called traditional accounting, records income when it is earned and expenses when they are incurred, regardless of when money changes hands. This gives a more accurate picture of your business's financial position at any given point in time.

Using the same example: if you invoice a client on 15 March, that income is recorded in March even if payment arrives in April. The unpaid amount sits as a debtor (accounts receivable) on your balance sheet until it is paid. If you want to understand balance sheets better, have a look at my guide on understanding your balance sheet.

Accrual accounting is mandatory for limited companies, and any self-employed person can choose to use it. It is also required if your annual trading income exceeds £150,000, at which point you can no longer use cash basis.

The advantages of accrual accounting include:

• Accurate financial picture: Your accounts reflect the true state of your business, including what you are owed and what you owe
• Full capital allowances: You can claim the Annual Investment Allowance and other capital allowances
• Better loss relief: Losses can be set against other income or carried back to previous years
• Required for growth: If you plan to seek investment, apply for business loans, or eventually incorporate, accrual accounts are far more useful
• Compliance ready: You are already prepared if your turnover exceeds the cash basis threshold

The downside is complexity. You need to track debtors, creditors, accruals, prepayments, depreciation, and potentially stock valuations. This is where having proper accounting software or a tool like Accounted can save you significant time and reduce errors.

Key Differences at a Glance

Understanding the practical differences between these two methods helps you make an informed choice. Here is how they compare across the areas that matter most to small business owners:

Income recognition: Cash basis records income when received; accrual records it when invoiced or earned. This can make a material difference to your taxable profit in any given year, especially if you have large invoices outstanding at your year end.

Expense recognition: Cash basis records expenses when paid; accrual records them when the liability arises. If you stock up on materials before your year end but have not paid for them yet, cash basis would not show that expense until payment is made.

Debtors and creditors: Cash basis does not track these; accrual does. This means cash basis accounts cannot tell you how much money is owed to your business, which can be a blind spot for credit management.

Capital allowances: Under cash basis, you deduct the actual cost of most items when purchased (with some exceptions for cars). Under accrual, you can claim formal capital allowances, including the Annual Investment Allowance, writing down allowances, and first-year allowances.

Loss relief: Cash basis losses can only be carried forward against future profits of the same trade. Accrual basis losses can be set against other income in the same year, carried back to the previous year, or carried forward. For more on how to make the most of your tax position, read my guide on tax deductions for sole traders.

Stock and work in progress: Cash basis does not require stock adjustments. Accrual basis requires you to value stock and work in progress at the year end, which affects your profit calculation.

Who Should Use Cash Basis?

Cash basis works best for sole traders and partnerships with relatively straightforward businesses. If you tick most of these boxes, cash basis is likely the right choice:

• Your annual turnover is well below £150,000
• You do not carry significant stock
• Your customers pay promptly (or you are paid at point of sale)
• You do not have large capital expenditure needs
• You do not need to claim loss relief against other income
• You are not planning to seek external finance in the near future

Typical businesses that suit cash basis include freelancers, consultants, tradespeople with low stock requirements, tutors, personal trainers, and many service-based sole traders. If you are just starting out, I have a guide on your first year of self-employment that covers choosing your accounting method alongside other key decisions.

One important caveat: even if you qualify for cash basis, it is not always the best choice. If your business regularly has significant amounts of unpaid invoices at year end, you might prefer accrual so that your profit figure (and therefore your tax bill) better matches your actual trading performance. This is particularly relevant for businesses that invoice large projects with payment terms of 30, 60, or 90 days.

Who Should Use Accrual Accounting?

Accrual accounting is the better choice — and sometimes the only option — in several situations:

• Your turnover exceeds or is approaching £150,000
• You carry significant stock or work in progress
• You have substantial capital expenditure and want to claim full capital allowances
• You need accurate financial statements for lenders, investors, or partners
• You want maximum flexibility with loss relief
• You run a limited company (accrual is mandatory)
• You have complex transactions involving foreign currency, long-term contracts, or multiple revenue streams

If you are considering the move from sole trader to limited company, accrual accounting is a necessity, and getting comfortable with it before incorporation saves time later. Check out my comparison of sole trader vs limited company structures for more on when incorporation makes sense.

How to Switch Between Methods

Switching from cash basis to accrual (or vice versa) is possible, but you need to make transitional adjustments to avoid double-counting income or expenses, or missing them entirely.

When moving from cash basis to accrual, you need to bring in opening debtors and creditors — these are amounts that were earned or incurred under cash basis but not yet settled. HMRC provides guidance on these adjustments on their basis period reform page.

When moving from accrual to cash basis, you need to reverse out closing debtors and creditors from the previous period, as these amounts will be picked up when they are actually paid or received under the new method.

These transitional adjustments can be spread over a period if they result in a significant tax charge, so it is worth planning the timing carefully. If you are using Accounted's features, the transition calculations are handled automatically, so you can focus on running your business rather than wrestling with spreadsheets.

Making Tax Digital and Your Accounting Method

With Making Tax Digital for Income Tax now in effect for many self-employed individuals, your choice of accounting method also affects how you submit quarterly updates to HMRC. Both cash basis and accrual are supported under MTD, but the information you report quarterly will differ.

Under cash basis, your quarterly updates will reflect actual cash received and paid during the quarter. Under accrual, they will reflect income earned and expenses incurred, including unpaid amounts. Either way, you need MTD-compatible software to submit your updates, and Accounted's pricing plans include full MTD compliance as standard.

My Recommendation

For most sole traders earning under £150,000, cash basis is the sensible starting point. It keeps things simple, reduces bookkeeping time, and means you only pay tax on money you have actually received. As your business grows, revisit the decision annually — particularly if you start carrying stock, making large capital purchases, or approaching the turnover threshold.

If you are unsure which method suits your business, sign up for Accounted and I will help you assess your situation. I can look at your income patterns, expense types, and business structure to recommend the approach that minimises your admin and keeps you compliant.

The most important thing is to be consistent within each tax year and to make informed transitional adjustments if you switch. Get this foundation right, and everything else in your bookkeeping and tax returns becomes significantly easier.

Accounted makes bookkeeping simple — Penny categorises your transactions automatically so you don't have to. See how →