Cash Basis vs Accruals Accounting — Which Is Right for Your UK Business?

The core difference

Cash basis accounting records income when money is received and expenses when they are paid. You pay tax on cash you have already received.

Accruals accounting records income when it is earned (even if unpaid) and expenses when they are incurred (even if not yet paid). You may pay tax on income you haven't received yet.

For most small businesses, the practical difference comes down to timing: cash basis delays tax in some situations, but it also restricts how you handle certain expenses and losses.

Who can use cash basis?

UK sole traders can use cash basis if their annual turnover is below £150,000. If you are in a partnership, all partners must use cash basis for it to apply.

You cannot use cash basis if you run certain types of business (Lloyd's underwriters, certain farming schemes) or if your business has significant interest income or complex financing arrangements.

When cash basis reduces your tax bill

Cash basis is beneficial when you have significant outstanding debtors at year end — clients who owe you money but haven't paid. Under accruals, that income appears in your profit and is taxed now. Under cash basis, it only appears when paid.

Example: You invoice £8,000 in March and are paid in May. Under accruals, the £8,000 is in your 2024/25 accounts. Under cash basis, it appears in 2025/26. This defers the tax by one year.

When cash basis works against you

Cash basis restricts loss relief. Under traditional accounting, if you make a trading loss, you can offset it against other income in the same tax year or carry it forward. Under cash basis, losses can only be carried forward against future profits from the same business — you cannot set them against other income.

If you have started a business and are expecting losses in the early years while also having employment income, accruals accounting gives you more flexibility to get relief on those losses quickly.

Cash basis also limits interest deductions — you cannot deduct more than £500 of interest and bank charges per year. For businesses with significant borrowing or overdrafts, accruals is more favourable.

Making the choice

For most sole traders with straightforward services and prompt-paying clients, the difference is small. HMRC's default position is that unregistered businesses must apply the cash basis rules — you have to actively elect out to use accruals.

Questions to ask yourself:

• Do I have significant year-end debtors? (Cash basis favours you)
• Do I have significant year-end creditors — expenses incurred but not yet paid? (Accruals favours you)
• Am I expecting losses that I want to offset against other income? (Accruals is better)
• Do I have significant business borrowing above £500 of annual interest? (Accruals is better)
• Is simplicity more important than tax optimisation right now? (Cash basis wins on simplicity)

Switching between methods

You can switch from cash basis to accruals (or back) when you complete your Self Assessment return. The switch requires transition adjustments to avoid double-counting or omitting income and expenses. Your bookkeeper or accountant can calculate these.

Do not switch without considering the tax implications in the transition year — it can create a larger-than-expected bill.