As a small business owner you might be wondering which accounting method to use: accrual accounting or cash basis accounting, which is now the default.
You’ll need to manage your books, not only for tracking your profits and filing your tax return, but for 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:
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.
Since 6 April 2024, cash basis accounting became the default way of accounting – meaning you’ll have to opt out if you want (or need) to use another method. And if you can’t use cash basis, then you’ll need to use traditional accounting to work out your taxable profits.
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 2024, but unfortunately don’t get paid until 12 April 2024
- while you did the work in the 2023-24 tax year, you didn’t get paid until 2024-25
- the money counts as income for 2023-24, 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 2024
- 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
If you don’t want to use cash basis accounting for your business, you’ll need to tick the opt out box when you file your Self Assessment tax return.
Can my small business use cash basis accounting?
As of 2024, cash basis accounting is the default method – but only if you’re eligible, as 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.
Meanwhile VAT-registered businesses…
- 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).
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.
Traditional accounting vs cash basis
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
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 | Larger or complex businesses Limited companies Liability partnerships | How to register as self-employed and choose a business structure |
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 |
Have you used both accounting methods for your business? Let us know your favourite in the comments below.
Useful small business guides
- How to do a self-employed tax return
- Best accounting software for small businesses
- What’s the difference between a business merger and an acquisition?
- What type of business insurance do I need?
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