Cash Basis vs Accruals Accounting: What's the Difference?

When you're running a UK limited company, one of the first decisions you'll need to make about your bookkeeping is which accounting method to use: cash-basis or accruals accounting.

Both are legitimate accounting methods, but they work quite differently and suit different types of businesses. Let's break down what each method means and help you understand which might be right for your company.

What is Cash-Basis Accounting?

Cash-basis accounting is the simpler of the two methods. With cash-basis accounting, you record income and expenses when money actually moves in or out of your bank account.

For example:

• You invoice a client on 15 January, but they pay you on 10 February. You record the income on 10 February (when the money arrives).
• You receive a supplier invoice on 20 March but pay it on 5 April. You record the expense on 5 April (when the money leaves your account).

This approach mirrors how most people naturally think about money—when did I actually get paid? When did I actually pay for something?

What is Accruals Accounting?

Accruals accounting (sometimes called "traditional accounting") is more complex. With this method, you record income and expenses when they're earned or incurred, regardless of when money actually changes hands.

Using the same examples:

• You invoice a client on 15 January. You record the income on 15 January, even though you don't receive the money until 10 February.
• You receive a supplier invoice on 20 March. You record the expense on 20 March, even though you don't pay until 5 April.

This method gives you a more complete picture of what your business owes and is owed at any given time, but requires tracking additional information like unpaid invoices (debtors) and unpaid bills (creditors).

Key Differences at a Glance

Which Method Should You Use?

The right method depends on your specific circumstances:

Cash-Basis May Be Better If:

• You're a micro-entity (small limited company)
• You're not registered for VAT
• Most of your income and expenses are straightforward
• You don't carry significant stock or inventory
• You want simpler bookkeeping
• Your customers generally pay quickly

Accruals May Be Necessary If:

• You're registered for VAT (VAT accounting must use accruals principles)
• You carry significant stock or inventory
• You have long payment terms with customers or suppliers
• You need detailed tracking of who owes you money
• Your business is growing and becoming more complex

Can You Switch Between Methods?

Yes, you can switch between cash-basis and accruals accounting, but there are some important considerations:

• You should generally stick with one method for a full accounting year
• Switching requires careful transition accounting to avoid double-counting or missing transactions
• Your accountant will need to make appropriate adjustments when you switch
• Once you're VAT-registered, you effectively can't use pure cash-basis anymore

Micro-Entities and Cash-Basis Accounting

For UK micro-entity limited companies (very small companies meeting certain size thresholds), cash-basis accounting is often the most practical choice. It's:

• Easier to understand: You're simply recording what goes in and out of your bank
• Less time-consuming: No need to track complex debtors and creditors
• More affordable: Simpler records often mean lower accountancy fees
• Better for cash flow management: Your accounts show your actual cash position

Getting Professional Advice

While cash-basis accounting is simpler, it's still important to get advice from a qualified accountant when setting up your bookkeeping system. They can help you:

• Determine which method is most appropriate for your business
• Understand any legal requirements specific to your industry
• Set up your bookkeeping correctly from the start
• Plan for future changes as your business grows