Cash vs Accrual Accounting: Which Should Your Small Business Use?

When does a sale count as income: when you send the invoice, or when the money lands in your bank? Your answer decides whether you use cash or accrual accounting, and it changes what your profit looks like month to month. This guide explains both methods with simple examples and helps you work out which suits your business.

Cash accounting: when money moves

Under cash accounting, you record income when you receive payment and expenses when you pay them. Unpaid invoices and unpaid bills don't appear in your income or expenses until money changes hands.

Pros: simple, intuitive, and your income figure matches what's actually in the bank. Cons: profit swings with payment timing, and you can't easily see what you're owed or what you owe.

Accrual accounting: when it's earned or owed

Under accrual accounting, you record income when you earn it (usually when you invoice) and expenses when you incur them (when you receive the bill), whenever the cash moves.

Pros: a truer picture of profitability, comparable months, and you always know your receivables and payables. Cons: more to track, and profit can look healthy while cash is tight.

The same month, two ways

Say in March you invoice £6,000 of work, but customers only pay £2,000 by the month's end. You receive a £900 supplier bill and pay £400 of it, and pay £1,000 rent.

Neither number is wrong; they answer different questions. Cash basis says "how much cash did my trading produce?" Accrual says "how much did I actually earn this month?"

Which can you use?

That depends on where you are and how your business is set up, so check with your accountant or tax authority:

• Companies generally prepare accounts on an accrual basis.
• Sole traders and partnerships often have a choice. In the UK, HMRC's cash basis is now the default for many self-employed people, with the option to use accrual accounting instead.
• VAT can have its own cash or accrual schemes, separate from how you calculate profit.

How to choose

Choose cash accounting if you're a sole trader or small partnership with simple finances, get paid quickly (or at the point of sale), don't hold much stock and want the simplest possible records.

Choose accrual accounting if you invoice on credit terms, have significant payables or stock, want accurate monthly profit to make decisions, or plan to grow, borrow or incorporate.

Why many small businesses end up on accrual

Even businesses that start on cash often move to accrual as they grow, because it shows what's really happening: who owes you, what you owe and whether each month's work was profitable. Pair it with an aging report to keep an eye on cash, and you get the best of both.

How double entry fits in

Double-entry bookkeeping records receivables and payables as accounts, which is exactly what accrual accounting needs. Posting an invoice debits accounts receivable and credits sales; the payment later moves the amount from receivables to your bank. See double-entry bookkeeping explained for the mechanics, and how to read a P&L for what the result looks like.

Accrual bookkeeping without the effort

Zelvorm Books records invoices and bills when they're posted and payments when they arrive, so receivables, payables and accrual-based reports stay current automatically. It's free double-entry bookkeeping for small businesses.

Month-end adjustments under accrual accounting

Accrual accounting asks one question at month end: does every income and cost sit in the month it belongs to? Common adjustments:

Small businesses often keep this light: invoicing promptly and entering bills by their date handles most of it. Your accountant usually makes the remaining adjustments at year end.

Deferred income and prepayments, explained

• Deferred income is money received before you've earned it, such as a deposit or annual subscription paid upfront. It's a liability until you deliver.
• Prepayments are costs paid before you've used them, such as a year's software licence. They're an asset that's used up over time.

Both exist only in accrual accounting, and both stop one month looking unusually good or bad.

What it means for VAT

How you account for VAT can be separate from how you calculate profit. In the UK, for example, HMRC's VAT Cash Accounting Scheme lets eligible businesses pay VAT when customers pay them rather than when they invoice, which helps cash flow if customers pay slowly. Eligibility depends on turnover and other rules, so check HMRC's guidance or ask your accountant.

Switching methods

If you start on cash and move to accrual:

1. Pick a switch date, usually the start of a financial year.
2. List unpaid invoices and bills at that date and record them as receivables and payables.
3. Avoid double counting. Income already counted when invoiced shouldn't be counted again when paid.
4. Ask your accountant about any tax adjustments needed for the change.

Which tells you more about your business?

For decisions, accrual usually wins: it shows whether each month's work was profitable, and it puts what you're owed and what you owe in plain sight. For survival, cash is king: a profitable business can still run out of money. The best answer for most small businesses is accrual bookkeeping plus a close eye on cash, through your bank balance and your aging report.

Common mistakes

• Mixing methods: recording some sales when invoiced and others when paid.
• Forgetting unpaid bills under accrual, which makes profit look higher than it is.
• Treating customer deposits as income before the work is done.
• Assuming the VAT method and the profit method must be the same.

For the mechanics of recording all this, see double-entry bookkeeping explained.

The short version

Cash accounting records income and expenses when money moves; accrual records them when they're earned or owed. Cash is simpler; accrual is truer. Check which your business is allowed or required to use, and choose the one that helps you make better decisions.