If you’re starting up your business, then there are plenty of decisions to make. One of these is whether to use cash-basis or traditional accrual basis accounting in your bookkeeping. An accountant will advise you which is the best method for your particular business, but having an understanding doesn’t hurt!
What is traditional accrual accounting?
The accrual method of accounting, sometimes also known as traditional accounting or accrual basis, means your accounts must include every single invoice you send and receive when you work out your tax return, whether the invoice has been paid or not.
It means you’ll pay tax on the income you expect to receive from an invoice, even if the customer hasn’t paid it yet. As accountants like to joke, “it’s accrual world”.
An example of traditional accrual accounting
You invoice a customer at the end of March 2026 (the 2025/26 tax year). They don’t pay you until May 2026 (the 2026/27 tax year). The invoice is recorded in the 2025/26 tax year accounts, rather than 2026/27.
Traditional accounting requires you to keep records of all income and expenditure, such as:
- Any business assets which you purchase (stock and equipment)
- The value of stock at the end of your accounting period
- Payments to employees (wages, bonuses, benefits etc)
- Business vehicle and travel costs
- Bank or building society interest
- Declaring any other income
Traditional accounting generally suits larger businesses, but it’s worth considering – especially if you predict quick growth for your business.
What is cash basis accounting?
Unlike traditional accounting, businesses using cash basis accounting only include invoices and expenses in their tax return once they’re actually paid. This does mean you can’t claim something as an expense unless you’ve paid for it, but it also means you won’t pay tax on any invoices until your customer pays you.
You’ll need to opt out if you prefer to use a different method, or if cash basis accounting isn’t appropriate for you.
An example of cash basis accounting
You invoice a customer at the end of March 2026 (the 2025/26 tax year). They don’t pay you until May 2026 (the 2026/27 tax year). The invoice is recorded in the 2026/27 tax year accounts, rather than 2025/26.
The treatment of some items is different depending on which type of accounting you use. For example:
- Payments for equipment are allowable expenses
- There is a maximum of £500 allowable as an expense for interest paid on cash borrowings
- You can’t offset losses against your other income
- You can’t claim capital allowances on anything except for cars.
Who can use cash basis accounting?
Cash basis accounting isn’t an option for limited companies or Limited Liability Partnerships (LLPs) but it’s generally suitable for smaller sole trader businesses with a turnover less than £150,000. You can continue using cash basis accounting as your business grows, up to a total business turnover of £300,000 per year. If you reach the threshold then you’ll need to use the traditional accrual basis of accounting on your next tax return.
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