Cash vs Accrual Accounting: Which Should Your Business Use?

Two bookkeepers close the same month for the same business. One reports a £4,000 profit. The other reports a £3,000 loss. Neither has made a mistake — they're using different accounting bases, and the difference is simply when a transaction gets recorded.

That timing choice affects your profit figure, your tax position, your ability to borrow, and, most importantly, whether your numbers actually tell you how the business is doing. Here's how each basis works, what each one hides, and how to choose.

The Difference in One Line

Cash basis: record income when the money arrives, and expenses when the money leaves.

Accrual basis: record income when you earn it, and expenses when you incur them — regardless of when cash moves.

That's the entire distinction. Everything below is a consequence of it.

The Same Month, Both Ways

A small design studio, month of March:

• Finished and invoiced a £10,000 project. The client pays in April.
• Received £6,000 from a project completed and invoiced in February.
• Paid £2,000 of contractor invoices from February's work.
• Received a £3,000 contractor invoice for March's work, due in April.
• Paid £1,000 for twelve months of software, up front.

On a cash basis — count only money in and out:

On an accrual basis — count what belongs to March:

Same business, same month. The cash view says £3,000; the accrual view says roughly £6,917. Neither is a lie. The cash view is telling you what happened to your bank balance. The accrual view is telling you what your March trading actually earned.

Note the software line especially. Under accrual, a twelve-month prepayment is spread across the twelve months it covers, so one month of trading isn't distorted by a payment that benefits the whole year. That treatment — matching costs to the period they relate to — is the core idea of accrual accounting.

What Each Basis Hides

Cash basis hides your commitments. Money in the bank looks like profit even when you owe most of it. A business that has invoiced nothing for two months but is collecting old invoices looks healthy right up until the collections run out. It also makes performance look lumpy: the month a big invoice lands is a great month, and the month before it — when the work was actually done — looks terrible.

Accrual basis hides your bank balance. This is the more dangerous blind spot, and it's why profitable businesses go under. Accrual profit is not cash. You can post a strong profit while every customer is 60 days late paying and your bank account is empty. Anyone running on accrual needs to look at cash separately and constantly — the cash flow statement exists precisely because profit doesn't tell you about liquidity.

The practical conclusion most owners reach: run accrual for decisions, and watch cash weekly regardless. They answer different questions, and you need both answers.

Which One Should You Use?

Work through these.

1. Do you hold inventory? If you buy stock and sell it later, cash basis will mislead you badly — a big purchase looks like a terrible month, and selling it looks like a windfall. Accrual matches the cost of goods to the sale that used them, which is the only way to see a real gross margin.

2. Do you invoice, or get paid at the point of sale? If customers pay immediately and you pay suppliers immediately, the two bases produce nearly the same numbers, and cash basis is simpler. The bigger the gap between doing the work and getting paid, the more accrual tells you that cash cannot.

3. Do you take payment up front for work delivered later? Deposits, retainers, annual subscriptions, prepaid packages. On cash basis, that money is income the day it arrives — which flatters this month and starves the months when you actually do the work. Accrual recognises it as you earn it, which is the honest picture.

4. Who reads your numbers? Lenders, investors, and acquirers generally expect accrual statements, because they want comparable performance rather than bank-balance movement. If you'll be raising money or selling within a few years, running accrual now means you'll have history in the format they'll ask for.

5. What are you required to do? This is the constraint, not a preference. Many jurisdictions permit cash-basis accounting only for smaller businesses below a turnover threshold, or only for certain business structures, and the rules for tax reporting may differ from the rules for statutory accounts. Thresholds and eligibility change and vary by country. Check the current rules with a qualified accountant for your jurisdiction and structure — this article is general education, not tax advice.

A Reasonable Default

For most small service businesses that invoice on terms: accrual for management accounts, with a weekly cash view alongside.

That means:

• Your profit and loss shows revenue in the month you did the work.
• Your balance sheet shows what customers owe you (receivables) and what you owe suppliers (payables) — the two numbers cash-basis reporting simply doesn't produce.
• A short rolling cash forecast tells you what will actually be in the bank in six weeks.

Modern bookkeeping software handles both. Most packages record on an accrual basis and can produce cash-basis reports on demand, which is exactly the flexibility you want — one set of records, two views. If you're choosing a package, this is worth checking explicitly; our guide on choosing accounting software covers what else matters.

For the wider picture of how these numbers fit together, see the three financial statements explained — and for the gap between profit and bank balance, managing cash flow.

Switching Bases

If you decide to move from cash to accrual, three practical points:

It's not just a setting. You need opening balances for what customers owe you and what you owe suppliers at the switch date, plus any prepayments and deferred income. Without those, your first accrual period double-counts or misses whole transactions.

Pick a clean boundary. The start of a financial year is far easier than mid-year, because it avoids a period that's half one basis and half the other.

There may be reporting consequences. Changing the basis you report on can affect your tax position and may require notification or specific transitional treatment. Get an accountant to handle the changeover — this is one of the genuinely worthwhile hours of professional time a small business can buy.

Frequently Asked Questions

What's the main difference between cash and accrual accounting? Timing. Cash basis records transactions when money moves; accrual records them when the income is earned or the cost is incurred.

Is cash basis accounting easier? Yes — it maps closely to your bank statement and needs less judgement. That simplicity is exactly why it's a poor decision tool once you hold stock or invoice on terms.

Can a business be profitable on accrual and still run out of money? Very much so, and it's one of the most common ways small businesses fail. Accrual profit says nothing about whether the cash has arrived. Track both.

Which basis do lenders and investors expect? Accrual, generally, because it shows trading performance in the period it happened and produces a balance sheet with receivables and payables on it.

Do I have to choose one for everything? Your statutory and tax reporting must follow the rules that apply to you, but you can look at your own numbers however you find useful. Many owners review accrual management accounts monthly and a cash position weekly.

Choose the View That Answers Your Question

Cash tells you what's in the bank. Accrual tells you whether the business is working. Growing businesses need both, and the mistake isn't picking one — it's assuming the single number you're looking at answers a question it was never designed to answer.

Once you know which basis you're on, put real numbers through it — run your margin, break-even, and ROI figures in the free calculators on SortProfit and see what the answer looks like when the timing is right.