Cash basis or accruals basis | Severn Accounting

When it comes to recording your business finances, one of the earliest decisions you’ll make is whether to use the cash basis or accruals basis of accounting. Both methods are accepted by HMRC, but they can produce very different results—especially when it comes to your tax bill. Understanding the difference is essential for getting your accounts right and making sure you’re not paying more tax than you need to.

At Severn Accounting, we work with Worcester-based businesses of all sizes, and we’ve seen how choosing the wrong accounting method can create unnecessary complications. This post will walk you through both approaches, so you can make an informed decision for your business.

What is the cash basis?

Under the cash basis, you record income and expenses only when money physically changes hands. If a client pays you in January, that’s when you record the income—regardless of when you actually did the work. Similarly, you only record expenses when you’ve actually paid them.

The cash basis is simpler to manage and is often favoured by sole traders and small partnerships. There’s less paperwork, fewer adjustments needed at year-end, and your accounts reflect actual cash flow rather than accounting theory.

However, there’s an important restriction: from 6 April 2024, the cash basis is only available to businesses with turnover below £150,000 in the previous tax year. If your turnover exceeds this threshold, you must switch to accruals basis accounting, regardless of your preference.

What is the accruals basis?

The accruals basis (also called the accrual method) records income and expenses when they are incurred, not when payment is made. If you invoice a customer in March but don’t receive payment until May, you still record the income in March. You also record expenses when you’ve committed to them, even if you haven’t paid yet.

This method gives a more accurate picture of your business’s true profitability in any given period. It’s the standard approach for larger businesses and limited companies and is required if your turnover exceeds the £150,000 threshold.

The trade-off is complexity. You’ll need to track invoices issued, amounts owed to you, and outstanding bills. You’ll also need to make adjustments at year-end for accrued income and prepaid expenses. This typically requires professional accountancy support, which adds cost—but it’s often worth the investment for accuracy and compliance.

Which one should you choose?

If your turnover is below £150,000, you have a genuine choice. Here are some practical considerations:

Cash basis suits you if: you operate on a cash-only or mostly upfront payment model, your business is straightforward with few outstanding invoices or bills, and you want minimal administrative burden. Many service providers, tradespeople, and small retailers find this works well.
Accruals basis suits you if: you extend credit to customers (even occasionally), you have significant outstanding invoices or supplier bills, or you’re planning to grow and anticipate exceeding the £150,000 threshold soon. It’s also preferable if you want a clearer picture of profitability rather than just cash position.

If your turnover exceeds £150,000, the decision is made for you: you must use accruals basis accounting.

One further consideration: limited companies must always use accruals basis, regardless of turnover. If you’re trading as a limited company, this isn’t optional.

Getting it right matters

Choosing the wrong method—or worse, switching methods inconsistently—can flag your returns as high risk during an HMRC inspection. HMRC expects consistency, and if you switch methods without good reason, you may face questions about your tax position.

It’s also worth noting that some accounting software makes one method easier than the other, so your choice might be influenced by the tools you’re already using or planning to adopt.

The takeaway

Both cash and accruals basis are valid under HMRC rules, but they’re not interchangeable. The cash basis is simpler and works well for small, straightforward businesses below the £150,000 threshold. The accruals basis is more comprehensive and is mandatory once you exceed that threshold or if you operate as a limited company.

The key is choosing the right method for your situation and sticking with it consistently. Get it wrong, and you risk miscalculating your tax position or facing complications during an inspection.

For tailored advice, contact Severn Accounting—we’re here to help.