What’s the difference between accruals basis accounting and cash basis accounting?

If you’re a small business owner or landlord, you may have heard of the two methods of accounting: accruals basis accounting, which is sometimes called ‘traditional accounting’, and cash basis accounting. In this guide, we explore the key differences between these two accounting methods and the factors to consider when choosing which to use.

Differences between accruals basis and cash basis accounting

The main difference between accruals basis accounting and cash basis accounting is the date upon which you record your income and costs.

Under the accruals basis of accounting, businesses and landlords record their income at the date displayed on invoices issued and on bills received.

Under the cash basis of accounting, businesses and landlords record their income and costs at the date the money comes in or is paid out.

Changes from 6th April 2024

From April 2024, cash basis accounting, where income or costs are recorded at the date the money is either received or paid out, is the default accounting method for self-employed businesses and partnerships with trading income.

Who can use cash basis accounting?

Business owners

Cash basis accounting is the default method of accounting for sole traders and partnerships for the 2024/25 tax year (which started on 6th April 2024) onwards.

If you have more than one business and wish to use cash basis accounting, you must use it for all your businesses. However, if you’re both a landlord and a business owner and use the cash basis of accounting for your property income, you’re still allowed to use accruals basis accounting for your business income.

VAT-registered sole traders and partnerships can also use the cash basis of accounting. This is different from using the cash basis to prepare your VAT returns, so please check with your accountant if you’re unsure which basis you should be using for your accounts. 

Limited companies and limited liability partnerships, along with some other specific types of business, can’t use the cash basis of accounting. 

Landlords

If you’re an unincorporated landlord (i.e. your properties are not owned by limited companies), you must use the cash basis of accounting unless you indicate on your Self Assessment tax return that you do not wish to use cash basis accounting.

As limited companies are not allowed to use cash basis accounting, incorporated landlords (whose properties are owned by a limited company) must use the accruals basis of accounting.

Who can use accruals basis accounting?

Businesses

From 6th April 2024, HMRC will presume that a business is using cash basis accounting unless the owner makes an election to use accruals basis accounting. Business owners can do this by marking the relevant box when filing their tax return.

Landlords

Unincorporated landlords (landlords whose properties are not owned by limited companies) who want to use accruals basis accounting must indicate that they wish to do so on their Self Assessment tax return. 

As limited companies cannot use cash basis accounting, incorporated landlords must use the accruals basis of accounting.

Choosing an accounting method 

The accounting method you choose to use is likely to depend on your circumstances as a business owner or landlord.

Some people find the cash basis of accounting the easier method to understand, because it involves recording income and costs on the date on which they are received or paid. It provides a clearer picture of how much cash is available in a business at any given time. Under the cash basis of accounting, Income Tax is only due on money that’s been received, which means that business owners and landlords aren’t taxed on unpaid invoices at the end of the tax year.

HMRC doesn’t allow businesses with a combined business turnover (excluding property) of more than £150,000 per year to use cash basis accounting. Therefore, if you expect your business turnover to increase substantially in the near future, the cash basis of accounting may not be a long-term solution. If you’re already using the cash basis of accounting and you pass that threshold, you can stay in the scheme up to a combined business turnover of £300,000 per year, after which you’ll need to switch to accruals basis accounting for your next Self Assessment tax return.

There’s a variety of additional circumstances in which cash basis accounting may not be the best choice for a business. If you’re in any doubt as to which accounting method to choose, we recommend that you speak to an accountant.

Choosing an accounting method in FreeAgent

FreeAgent supports both cash basis accounting and accruals basis accounting. When you set up a sole trader or partnership account, you can choose which accounting method to use.