Cash Basis vs Accrual Accounting: Which Should Your UK Business Use?

Should Your Business Use the Cash Basis for Tax?

For many UK unincorporated businesses, the cash basis is now the default method for calculating taxable profits. Under this approach, income is taxed when received, and expenses are deducted when paid. This means you don’t need to account for debtors, creditors, prepayments, or accruals. A major advantage is that relief for bad debts is automatic, as income is only recognized when received. Capital expenditure is generally treated as a deductible expense, except for items explicitly excluded under the cash basis, such as cars. Most sole traders and partnerships made up entirely of individuals automatically qualify for the cash basis unless they choose to opt out.

However, the cash basis isn’t suitable for every business, and some may intentionally prefer the accrual method.

Who Can’t Use the Cash Basis?

The accrual basis records income and expenses when earned or incurred, regardless of when money changes hands. Certain businesses are required to use the accrual method because they fall into HMRC’s excluded categories. These include:

• Limited companies and LLPs

• Partnerships that include a corporate partner

• Some farming or creative businesses using specific tax reliefs (e.g., profit averaging or herd basis)

• Businesses required to produce accounts under International Financial Reporting Standards

For these businesses, the accrual basis isn’t optional—it’s mandatory.

Why Some Businesses May Opt Out

Even if eligible for the cash basis, some businesses may benefit from using accrual accounting. Reasons to consider opting out include:

• Long-term projects or work in progress: The accrual method tracks costs and revenues throughout a project, aiding financial management.

• High stock levels: Accrual accounting helps accurately calculate profit margins and stock turnover ratios.

• Customer credit: Unlike the cash basis, the accrual method accounts for bad debts.

• Purchasing assets or stock on credit: Tax relief is delayed under cash accounting until payment is made, which can impact cash flow for large purchases.

• Plans to incorporate: Post-incorporation accounts must follow the accrual basis, so aligning pre-incorporation accounts can avoid overlaps.

• Need for external funding: Lenders and investors usually prefer accrual-based accounts as they give a clearer picture of a business’s financial health.

Practical Consideration

It’s important to note that the cash basis for income tax is separate from VAT cash accounting. This means a business can use the cash basis for income tax while still using the standard accrual method for VAT submissions, or vice versa.

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