TL;DR — Key Takeaways
- Cash basis records income when received and expenses when paid — simpler, used by most sole traders.
- Accrual basis records income when earned and expenses when incurred — required for limited companies and businesses over £150,000 turnover.
- HMRC allows most sole traders and partnerships to use cash basis if turnover is under £150,000.
- Limited companies must use accrual (traditional) accounting — no choice.
The Core Difference
The difference between cash and accrual accounting comes down to timing — specifically, when you record income and expenses in your books.
Under cash basis accounting, you record a transaction when money actually changes hands. You sent an invoice in January but didn't get paid until March? Under cash basis, that income appears in March. Under accrual accounting, you record the income in January — when you earned it — regardless of when the cash arrives.
Real Example: £15,000 Contract Paid in 3 Instalments
A consultant invoices £15,000 in January for a 3-month project, paid in one lump sum in March.
- Cash Basis
- Accrual Basis
Cash basis shows £0 in Jan/Feb, £15k in March. Accrual spreads £5k across each month.
Cash Basis Accounting: Explained
Cash basis is the simpler of the two methods. HMRC introduced it specifically to reduce the administrative burden on small businesses. Here's how it works in practice:
✅ Pros of Cash Basis
- Simpler — you only track actual money movements
- No need to track debtors or creditors
- Tax is based on cash received — better cash flow
- Easier to understand without accounting knowledge
- Preferred by HMRC for sole traders under £150k
❌ Cons of Cash Basis
- Doesn't show a true picture of profitability
- Can't claim losses against other income
- Interest deductions capped at £500/year
- Not suitable for businesses with significant stock
- Can't be used by limited companies
Accrual (Traditional) Accounting: Explained
Accrual accounting follows the matching principle: income and expenses are recorded in the period they relate to, regardless of when cash moves. This gives a more accurate picture of your business's financial health at any given moment.
✅ Pros of Accrual Basis
- More accurate picture of profitability
- Required for limited companies
- Better for businesses with credit terms
- Allows loss relief against other income
- Required by banks for loan applications
❌ Cons of Accrual Basis
- More complex — requires tracking debtors/creditors
- You may pay tax before receiving cash
- Requires more accounting knowledge
- More time-consuming to maintain
- Usually requires an accountant
HMRC Rules: Who Can Use Each Method?
| Business Type | Cash Basis | Accrual Basis | Notes |
|---|---|---|---|
| Sole trader (under £150k turnover) | Cash basis is the default from 2024/25 — opt out to use accrual | ||
| Sole trader (over £150k turnover) | Must use accrual basis | ||
| Partnership (under £150k per partner) | Each partner's share must be under £150k | ||
| Limited company | Must use accrual — no choice | ||
| LLP (Limited Liability Partnership) | Must use accrual basis | ||
| Property landlord (under £150k) | Cash basis available for property income |
Important: HMRC Changed the Default in 2024/25
From the 2024/25 tax year, cash basis became the default for sole traders and partnerships. Previously, accrual was the default and you had to opt in to cash basis. Now it's reversed — you must actively opt out of cash basis if you want to use accrual accounting. Check your software settings to ensure you're using the correct method.
Which Method Is Right for You?
You're a sole trader or freelancer with straightforward income
→ Use cash basis
It's simpler, HMRC-approved, and the default from 2024/25. Your accounting software will handle it automatically.
You have significant unpaid invoices or stock at year-end
→ Consider accrual
Cash basis can distort your profitability if you have large amounts owed to you or significant stock levels.
You're a limited company
→ Accrual only
Limited companies must use accrual accounting — there's no choice. Your software will be set up this way by default.
You're planning to grow and seek investment or bank finance
→ Use accrual
Banks and investors require accrual-based accounts. Switching later is disruptive — better to start right.
You're a property landlord
→ Cash basis is fine
HMRC allows cash basis for property income under £150k. It simplifies your record-keeping significantly.
How Accounting Software Handles Both Methods
Most modern UK accounting platforms support both methods, though the way they handle them varies:
| Software | Cash Basis | Accrual | Notes |
|---|---|---|---|
| QuickBooks | Switch between methods in settings — reports update instantly | ||
| Xero | Accrual default; cash basis reporting available | ||
| FreeAgent | Cash basis built in for sole traders; accrual for companies | ||
| Sage Accounting | Supports both; defaults to accrual | ||
| QuickFile | Cash basis available; good for sole traders | ||
| FreshBooks | Cash basis only — not suitable for limited companies |
Switching Methods: What You Need to Know
Switching from cash basis to accrual (or vice versa) mid-year requires transitional adjustments to avoid double-counting income or expenses. HMRC has specific rules for this. If you're considering switching, do it at the start of a new tax year and consult your accountant first.