Accrual vs Cash Accounting: What’s the difference & Which is right for your business?

Choosing between Accrual accounting vs Cash accounting is crucial for businesses. Each method records transactions differently and impacts financial reporting.

Understanding these differences helps you make informed decisions. The right choice depends on your business size, structure and financial complexity.

From April 2024, HMRC presumes businesses use cash basis unless they elect accrual accounting. This makes understanding both methods essential.

In this guide, we’ll discuss:

• What cash accounting is and how it works
• What accrual accounting is and how it works
• Key differences between the two methods with real-life examples
• Advantages, disadvantages, and compliance requirements
• Guidance on which method suits different business types

What is Cash Accounting?

Cash basis accounting records transactions only when money changes hands. You recognise income when payment arrives and expenses when bills are paid.

This cash method of accounting is straightforward and intuitive. No complex calculations or future commitments are tracked.

With cash basis you only record income or expenses when you receive money or pay a bill. This simplicity makes it popular with small businesses.

How Cash Accounting method works?

The cash accounting method follows these principles:

• Record income when cash is received
• Record expenses when payments are made
• No tracking of unpaid invoices or bills
• Focus on actual cash flow

What is cash accounting in practice? Imagine selling £1,000 worth of services in March. You only record this income when the customer pays in April.

Similarly, if you buy equipment in December but pay in January, you record the expense in January’s accounts.

Cash accounting provides a clear view of actual cash flow, making it simpler for small businesses to manage their finances. However, it may not provide a full picture of financial health since it excludes outstanding receivables and payables.

What is Accrual Accounting?

Accrual accounting records transactions when they occur, regardless of payment timing. This provides a complete financial picture.

The accrual accounting method matches income with related expenses in the same period. This gives better insight into business performance.

What is accrual accounting exactly? It recognises economic events as they happen, not when cash moves.

How the Accruals basis of Accounting functions

The accruals basis of accounting operates on these principles:

• Income recorded when earned
• Expenses recorded when incurred
• Tracks outstanding invoices and unpaid bills
• Matches revenues with related costs

Using our previous example, a £1,000 March sale appears in March accounts. Payment timing doesn’t affect when it’s recorded.

Note: Accrual accounting provides a more accurate view of financial health, especially for businesses with credit sales or purchases, by tracking all financial obligations and resources. It is commonly used by larger businesses and those required to comply with accounting standards.

Key differences between Cash vs Accrual Accounting

The following table summarizes the main distinctions between cash and accrual accounting methods across key accounting aspects.

Aspect	Cash Accounting	Accrual Accounting
Income Recognition	When payment received	When service provided
Expense Recording	When bill paid	When cost incurred
Financial Picture	Current cash position	Complete business performance
Complexity	Simple to manage	More detailed tracking
Suitable For	Small businesses	Growing/larger businesses

Accrual Accounting Example

ABC Consulting completes a £5,000 project in December 2024. The client pays in February 2025.

Accrual accounting records:

• December 2024: £5,000 income
• Associated project costs in December
• Outstanding receivable until payment

Cash Accounting Example

The same ABC Consulting transaction under cash accounting:

• December 2024: No income recorded
• February 2025: £5,000 income recorded
• Expenses recorded when actually paid

This shows how accrual accounting provides a more accurate view of when income is earned and expenses are incurred, helping businesses better match revenues and costs in the correct period. In contrast, cash accounting focuses on actual cash flow timing, which may delay income and expense recognition but simplifies bookkeeping.

Who Should Use Each Method?

Cash or Accrual Accounting for Small Businesses

The cash basis is now the default method for preparing accounts. Most sole traders and small partnerships benefit from cash accounting.

Cash or accrual accounting choice depends on:

• Annual turnover levels
• Business complexity
• Future growth plans
• Investor requirements

When Cash Basis is Suitable

Cash basis works well for:

• Sole traders and small partnerships
• Service-based businesses
• Simple transaction structures
• Businesses wanting straightforward bookkeeping

Note: Eligible small businesses can use the cash basis method depending on their turnover and simplicity of operations, but those exceeding certain revenue thresholds (currently £85,000) may need to adopt accrual accounting for regulatory or compliance purposes.

When Accrual Basis is Required

Accrual accounting is mandatory for some businesses, except for VAT where cash basis can be used.

Required for:

• Limited companies
• Businesses over certain turnover thresholds
• Those seeking investment
• Complex business structures

Note: Businesses with higher turnover, investors, or legal entity structures like companies generally must use accrual accounting to provide a complete financial picture and meet accounting standards.

Choosing between cash and accrual accounting should consider current business size, complexity, and future growth plans to ensure proper financial management and compliance with regulations.

Australia Legal Requirements and Changes

Cash Basis Changes 2024

This measure took effect from April 2024, with the first accounting year being the 2024/25 period.

Key changes include:

• Cash basis becomes the default method
• Removal of previous restrictions on its use
• Greater flexibility for businesses in choosing accounting methods

Cash accounting considerations

A business can use cash accounting if it is registered for certain sales-based charges and its estimated turnover is £1.35m or less.

Cash accounting for these charges on sales works differently from the approach used for income reporting. A business can choose different methods for each.

These options make it simpler to prepare accounts and give flexibility to select the method that suits how the business operates.

Accounting Methods Cash vs Accrual: Advantages and Disadvantages

Cash Accounting Benefits

Advantage	Description
Simplicity	Easy to understand and implement
Cash Flow Focus	Clear picture of available funds
Lower Costs	Minimal bookkeeping requirements
Flexibility for Small Operations	Helpful for freelancers and sole traders with simple transactions

Cash Accounting Limitations

Disadvantage	Description
Limited Insight	Doesn’t show complete business picture
Growth Challenges	Less suitable for expanding businesses
Loan Difficulties	Banks prefer accrual accounts
Planning Issues	Harder to forecast future performance
May Delay Income Recognition	Income recorded only when received, skewing short-term results
Not GAAP Compliant	Generally doesn’t comply with formal accounting standards

Accrual Accounting Benefits

Advantage	Description
Complete Picture	Shows true business performance
Better Planning	Enables accurate forecasting
Professional Image	More credible with stakeholders
Growth Ready	Suitable for expanding businesses
Compliance with Standards	Meets GAAP/IFRS requirements
Improved Cash Management	Tracks receivables and payables for pending cash flow

Accrual Accounting Limitations

Disadvantage	Description
Complexity	Requires more detailed record-keeping
Higher Costs	More expensive to maintain
Professional Help	Often requires accountant support
Requires Skilled Management	Needs knowledgeable personnel or accountants
More Time-Consuming	Increased administrative work can delay reporting

Switching Between Methods

Can You Change Accounting Methods?

Yes, businesses can switch between cash or accrual accounting methods. However, this requires careful planning and HMRC notification to the relevant regulatory authority.

Switching considerations:

• Tax implications of the change
• Timing of the switch
• Professional advice recommended
• Record-keeping adjustments needed

Accrual Versus Cash Basis of Accounting: Making the Switch

Changes came into force on 6 April 2024, the beginning of the 2024/25 accounting period.

The process involves:

• Deciding on the optimal timing for the change
• Calculating any transitional adjustments needed
• Updating accounting and record-keeping systems
• Notifying HMRC of the change

Practical Implementation of Cash vs. Accruals Accounting

Setting Up Cash Accounting

For cash basis accounting, the requirements include:

• Simple income and expense tracking
• Bank statement reconciliation
• Receipt and invoice filing
• Basic spreadsheet or accounting software

Setting Up Accrual Accounting

Accrual basis assumption requires more sophisticated systems:

• Accounts receivable tracking
• Accounts payable management
• Prepayment and accrual calculations
• Professional accounting software

Note: Cash basis accounting records transactions only when cash is received or paid, unlike accrual accounting which tracks transactions when they are incurred regardless of cash flow.

Software to Implement in Cash vs Accrual Accounting

Cash Accounting Software

Popular options include:

• Sage Business Cloud Accounting
• QuickBooks Online Simple Start
• FreeAgent (cash basis mode)
• Xero Starter (simplified features)

Accrual Accounting Software

Comprehensive solutions include:

• Sage Business Cloud Enterprise
• QuickBooks Online Advanced
• Xero Premium
• KashFlow Professional

Record-Keeping Requirements

Cash Basis Records

Accurate and detailed record-keeping is important in cash basis accounting, even though it seems simple.

Maintain:

• All income receipts
• Expense payments and receipts
• Bank statements
• Petty cash records

Accrual Basis Records

Additional requirements include:

• Outstanding invoice lists
• Unpaid bill schedules
• Accrual and prepayment calculations
• Month-end adjustment records

Best Accounting Methods for Australian Businesses

While this guide focuses on Aus rules, similar principles apply globally. The choice between methods depends on:

• Business size and complexity
• Regulatory requirements
• Industry standards
• Growth objectives

Professional Advice and Support

When to Seek Help

Consider professional assistance when:

• Starting a new business
• Switching accounting methods
• Facing complex transactions
• Preparing for growth or investment

Types of Professional Support

Available help includes:

• Qualified accountants
• Bookkeeping services
• Business consultants
• Financial software specialists who assist with implementing and optimizing accounting systems, especially for accrual accounting

Professional support like Outsourcing accounting and bookkeeping services can help businesses improve financial reporting accuracy, and support strategic decision-making beyond critical transition points.

Future-Proofing Your Choice

Planning for Growth

Consider future needs when choosing between accrual accounting vs cash accounting:

• Anticipated turnover growth
• Potential investors or lenders
• Business structure changes
• Market expansion plans

Regular Reviews

Assess your accounting method annually:

• Business performance changes
• New regulatory requirements
• Technology improvements
• Cost-benefit analysis

Accrual Accounting vs Cash Accounting for Businesses: Decision Framework

Use this framework to choose the right method:

Step 1: Assess Current Situation

• Calculate annual turnover
• Evaluate business complexity
• Consider cash flow patterns
• Review regulatory requirements

Step 2: Consider Future Plans

• Growth projections
• Investment needs
• Market expansion
• Structure changes

Step 3: Evaluate Resources

• Available time for bookkeeping
• Professional support budget
• Technology capabilities
• Staff expertise

Step 4: Make Informed Decision

• Compare method benefits
• Calculate implementation costs
• Plan transition if needed
• Set review schedule

Common Mistakes to Avoid

Cash Accounting Pitfalls

• Ignoring unpaid invoices in planning
• Mixing personal and business transactions
• Poor record-keeping despite simplicity

Accrual Accounting Errors

• Inconsistent cut-off procedures
• Missing accrual calculations
• Inadequate supporting documentation
• Complex adjustments without help

Compliance and Audit Considerations

HMRC Requirements

Both methods must comply with:

• Accurate record maintenance
• Timely tax return filing
• Supporting documentation
• Consistent application

Audit Readiness

Maintain audit trails through:

• Complete transaction records
• Regular reconciliations
• Document retention policies
• Professional review processes

Technology and Automation

Modern Accounting Solutions

Today’s software offers:

• Automatic bank feeds
• Receipt scanning capabilities
• Real-time reporting
• Cloud-based accessibility

Integration Benefits

Connected systems provide:

• Reduced manual entry
• Improved accuracy
• Time savings
• Better insights

Conclusion

The choice between accrual accounting vs cash accounting significantly impacts your business operations. Cash accounting offers simplicity but limited insight.

Accrual accounting provides comprehensive financial pictures but requires more effort. Consider your business size, complexity, and future plans.

From April 2024, HMRC will presume that a business is using cash basis accounting unless the owner makes an election to use accruals basis. This change emphasises the importance of making an informed choice.

Regular reviews ensure your chosen method continues serving your business needs. Professional advice helps navigate complex decisions and changes.

Frequently Asked Questions