Two ways to work out your profit for tax. Here is the difference in plain terms, and which one tends to suit smaller businesses.
Cash basis means you count income when money actually comes in and costs when they go out. Accruals, or traditional accounting, means you count income when you earn it and costs when you incur them, even if the cash moves later.
For many small businesses the cash basis is simpler and is now the default for sole traders, but accruals can give a truer picture for others. Here is how they compare.
The cash basis often suits smaller sole traders with simple affairs and no stock, who want to be taxed only on money actually received. It is the default for most sole traders for good reason.
Accruals often suits growing businesses, those carrying stock, or limited companies, where a truer picture of performance and more flexibility on losses and reliefs is worth the extra bookkeeping. Companies use accruals as standard.
For many small sole traders the cash basis is the simplest and sensible choice. As you grow, carry stock, or operate as a company, accruals usually gives a better picture and more flexibility. We will recommend the right basis for your business and keep the records to match.
For the 2024/25 tax year onwards, cash basis became the standard method of working out trading profits for sole traders and partnerships without corporate partners. Accruals accounting is still available, but you now have to elect into it rather than opt out of cash basis.
A great deal of published guidance still describes it the other way round, so it is worth being clear: if you do nothing, you are on cash basis.
Cash basis used to come with limits that made it unsuitable for anything but the smallest businesses. All three were removed for 2024/25.
That last one mattered most. The old rule was the main reason advisers steered clients away from cash basis, and it no longer applies.
Cash basis. Income counts when the money reaches you. Costs count when you pay them. An invoice you raised in March and were paid for in May falls into the later tax year. If you never get paid, there is nothing to write off, because you never recorded the income.
Accruals, or traditional accounting. Income counts when you earn it, whether or not you have been paid. Costs count when you incur them, whether or not you have paid them. Stock, debtors, creditors and prepayments all have to be measured at the year end.
This is the practical difference that catches people. Under cash basis, most equipment you buy to keep and use in the business is deducted as an ordinary business expense in the year you pay for it, rather than through capital allowances.
Certain things are excluded from that treatment, so no cash basis deduction is available: cars, land and buildings, assets with a useful life of more than 20 years, education and training, business acquisitions, and financial assets.
Cars are the one that matters most in practice. For a car you either claim capital allowances or use the flat rate mileage, currently 55p a mile for the first 10,000 business miles and 25p above that. Never both on the same vehicle.
Service businesses with little or no stock. Anyone who gets paid at the point of sale. Businesses where cash flow and the tax bill need to move together, because you are never taxed on money you have not received. And anyone who wants the bookkeeping to be as close to the bank statement as possible.
If you carry stock, accruals gives a truer picture and cash basis can distort profit badly in a year you buy heavily. If you invoice on long payment terms, accruals matches income to the work that earned it. If you need accounts a lender or investor will take seriously, accruals is what they expect to see. And if you want to recognise a bad debt as a deduction, you need accruals, because under cash basis the income was never recognised in the first place.
You can change method, but you cannot let income fall through the gap or count it twice. Adjustments are required in the year of change so that everything is taxed once and only once. It is not difficult, but it is the point at which mistakes are made, so it is worth getting the transition year checked rather than assumed.
Limited companies cannot use cash basis at all, and neither can partnerships with a corporate partner. Companies prepare accounts on the accruals basis, full stop.
Tell us a little about your situation and we will give you a straight, no obligation steer, then a fixed fee if you want us to handle it.