Cash vs Accrual Accounting: What’s the Difference?

Accounting isn’t just about counting beans — it’s also about when you count them. For small business owners and sole traders, one of the big choices you’ll face when it comes to bookkeeping is whether to use cash accounting or accrual (standard) accounting. Both methods are perfectly legitimate in the eyes of HMRC, but they paint slightly different pictures of your business finances. Let’s walk through what they mean, how they work, and why the choice matters.

What is cash accounting?

Cash accounting is exactly what it sounds like — you record income and expenses when the money actually moves.

• Income goes in the books when a customer pays you.

• Expenses are recorded when you pay your supplier.

No money changing hands? Then nothing is recorded yet.

Example: You send an invoice for £1,000 in March, but the client doesn’t pay until April. Under cash accounting, that £1,000 only appears in your April figures.

What is accrual (standard) accounting?

Accrual accounting, sometimes called “traditional” or “standard” accounting, records income and expenses when they’re earned or incurred, not when the money changes hands.

• Income is recorded when you raise the invoice.

• Expenses are recorded when you receive the bill, even if you don’t pay it straight away.

  
  

Example: That same £1,000 invoice from March? Under accrual accounting, it appears in your March figures, even if the cash doesn’t arrive until April.

Accrual accounting gives a more accurate picture of your business performance because it matches income and expenses to the period they relate to.

Cash vs accrual accounting in practice

Let’s say you’re a plumber. You finish a big job in March, invoice £2,000, and get paid in April. You also buy £500 of supplies in March but don’t pay the supplier until May.

• Cash accounting: You’d show £0 income and £0 expenses in March, because no money moved.

• Accrual accounting: You’d show £2,000 income and £500 expenses in March, because that’s when the work was done and the supplies were used.

One method tracks the cash in your pocket, the other tracks the economic activity of your business.

Pros and cons of cash accounting

Pros:

• Simple to use and understand.

• Helps with cash flow management — you only pay tax on money actually received.

• Less admin, because you don’t need to track debtors and creditors.

Cons:

• Doesn’t give a full picture of profitability if you’ve got lots of unpaid invoices or bills.

• Not available for limited companies or larger businesses.

• Can make your results look “lumpy” if payments are irregular.

Pros and cons of accrual accounting

Pros:

• Gives a true reflection of how your business is performing.

• Matches income and expenses to the right period.

• Required for larger businesses and all companies.

Cons:

• More complex to manage — you need to keep track of who owes you and what you owe.

• You may pay tax on income before you’ve actually received the cash.

• Can be trickier to handle for very small businesses where cash flow is king.

Side-by-side comparison

Feature	Cash Accounting	Accrual (Standard) Accounting
When income recorded	When money is received	When invoice is issued/earned
When expenses recorded	When money is paid	When bill is received/incurred
Simplicity	Simple	More complex
Cash flow view	Clear picture of cash in/out	Less focus on cash, more on profit
Profitability view	May be distorted by timing	More accurate, period by period
Eligibility	Sole traders/partnerships (<£150k)	All businesses, required for companies

Which taxes let you choose cash vs accrual?

The choice between cash and accrual accounting mainly applies to Income Tax for sole traders and partnerships.

• Income Tax (Self Assessment):

  • If your business turnover is under £150,000, you can opt for the cash basis instead of accrual.

  • Once turnover exceeds £150,000, you must switch back to accrual in the following year.

• Corporation Tax (limited companies):

  • Companies do not have the option of cash accounting. They must use accrual (standard) accounting rules, because Corporation Tax is based on statutory accounts prepared under UK accounting standards.

• VAT:

  • VAT has its own version of “cash vs accrual” called VAT Cash Accounting. Here, you account for VAT when payments are made or received rather than when invoices are raised.

  • Example: You invoice a customer £1,200 + VAT (£1,440 total) in January, but they don’t pay until March.

    • On standard VAT accounting, you’d still have to pay HMRC the £240 VAT in your January return, even though you haven’t been paid yet.

    • On VAT Cash Accounting, you don’t pay HMRC until March, when the money actually arrives.

      
      

This can be a huge help for businesses with slow-paying customers, because it stops you being out of pocket by paying VAT before you’ve got the cash in.

When VAT Cash Accounting might not be ideal

• If most of your sales are zero-rated (e.g. many food products), you’re usually reclaiming more VAT than you charge. In that case, standard VAT accounting could mean quicker refunds from HMRC.

• If your customers pay you promptly but you take longer to pay suppliers, standard VAT might again work better, because you can reclaim input VAT sooner.

So, if you’re a sole trader or small partnership, you have the flexibility to choose cash or accrual for Income Tax. If you’re running a limited company, it’s accruals all the way — though VAT Cash Accounting may still be an option.

Changing between methods

Sometimes, you may need or want to switch from one method to the other.

• Mandatory change: If you’re on cash accounting and your turnover goes above £150,000, you must switch to accrual accounting the following year.

• Voluntary change: Even if you’re eligible for cash accounting, you might choose to move to accrual if you want a clearer picture of profitability (for example, before applying for finance).

Switching requires adjustments to make sure income and expenses aren’t double-counted or missed, so it’s worth doing carefully — and usually with professional support.

Why the choice matters

Your choice of accounting method affects:

• How and when you pay tax – cash accounting means you only pay tax on money received, which can help with cash flow.

• How your accounts look – accrual shows profitability more accurately, which lenders, investors, or HMRC might prefer.

• What’s allowed – HMRC sets the rules, so not every business has a choice.

Final thoughts

At the end of the day, both cash and accrual accounting are tools designed to help you measure your business performance. Cash accounting is simple and great for smaller businesses focused on cash flow. Accrual accounting is more comprehensive and necessary as your business grows.

The key is understanding the difference, choosing the method that fits your circumstances, and knowing when it’s time to switch. Get that right, and you’ll not only stay compliant with HMRC but also have financial information that genuinely helps you make better decisions.