Cash vs accrual accounting: Key differences for your small business

Published Wednesday 26 November 2025

Table of contents

• Difference between cash and accrual accounting
• What is cash basis accounting?
• What is accrual basis accounting?
• Examples of cash vs accrual accounting
• Hybrid methods of accounting
• How to choose between cash and accrual accounting
• Cash vs accrual vs hybrid accounting
• Making the right choice for your business
• FAQs on cash vs accrual accounting

Key takeaways

• Choose cash accounting for simplicity and clear cash flow tracking, but select accrual accounting for accurate business performance insights and better decision-making capabilities.

• Recognize that from the 2024/25 tax year onwards, cash basis becomes the default accounting method in the UK, requiring businesses to actively opt-out if they prefer accrual accounting.

• Use accrual accounting if you hold stock, plan to apply for loans, or need detailed financial reporting, as it matches income and expenses to correct periods and provides lenders with clearer business performance data.

• Implement accounting software to automate accrual accounting processes, making it nearly as simple as cash basis while providing superior business insights through automated invoice tracking and bill entry.

Difference between cash and accrual accounting

Cash versus accrual accounting comes down to timing. When do you record revenue or expenses?

• Cash basis accounting: Record transactions when money actually changes handsAccrual basis accounting: Record transactions when you send invoices or receive bills

Accrual accounting gives you a more accurate picture of your business performance. Cash accounting is simpler but shows less detail about your business performance.

What is cash basis accounting?

Cash basis accounting records income and expenses only when money actually changes hands.

Here's how it works:

• Income: Only counts when you receive payment
• Expenses: Only counts when you pay bills
• Payment method: Works with cash, bank transfers, or electronic payments

This method shows your actual cash position, but it only includes money that has already changed hands.

Benefits of cash accounting

Simplicity: Easy to understand and manage – just track money in and outClear cash position: Shows exactly how much money you have availableTax advantages: You can calculate tax more simply. There is no cap on deducting interest from 2024/25 onwards.

Downsides of cash accounting

Profit timing: Shows profit based on cash flow, not on outstanding billsBusiness insights: Cash basis now allows you to offset losses in the same way as accrual accounting from April 2024Planning: Best for tracking current cash, not for forecasting future needs

What is accrual basis accounting?

Accrual accounting records transactions when they happen, not when money changes hands.

Here's how it works:

• Income: Recorded when you send an invoice
• Expenses: Recorded when you receive a bill
• Timing: Records transactions regardless of payment timing

This method matches income and expenses to the right period, so you see your true business performance.

Benefits of accrual accounting

Accurate performance: Shows true profitability by matching income and expenses to correct periodsBetter decisions: Provides complete financial picture for confident business planningLoan applications: Banks prefer accrual statements because they show your business performance more clearly

Downsides of accrual accounting

More complex: Requires tracking invoices, bills, and payments separatelyTax timing: May pay tax on unpaid invoices (though you can claim refunds if customers don't pay)Higher maintenance: Needs more detailed record-keeping than cash accounting

Examples of cash vs accrual accounting

Here’s how the two methods work for a small graphic design business.

Scenario 1: You send an invoice

You complete a project and send your client an invoice for £500 in March. The client pays you in April.

• With cash accounting, you record the £500 income in April, when the money actually arrives in your bank account.
• With accrual accounting, you record the £500 income in March, when you earned it and sent the invoice.

Scenario 2: You receive a bill

You sign up for a new software subscription and receive a bill for £50 in May. You pay the bill in June.

• With cash accounting, you record the £50 expense in June, when the money leaves your bank account.
• With accrual accounting, you record the £50 expense in May, when you received the bill and incurred the cost.

The accrual method gives you a more accurate picture of your profitability for a specific period, such as a month or a quarter.

Hybrid methods of accounting

Hybrid accounting combines both methods for different business purposes.

Common uses:

• Financial decisions: Use accrual for business planning and loan applications
• Tax purposes: Use cash basis for simpler tax calculations
• Reporting: Switch between methods based on audience needs

Hybrid systems have complex rules. Speak to an accountant to make sure you follow the regulations.

How to choose between cash and accrual accounting

Choose the method that fits your business. Here are some things to consider:

• Business size and turnover: Cash accounting is simpler, so many small businesses and sole traders use it. In the UK, turnover thresholds for using the cash basis have been removed from the 2024/25 tax year onwards.
• Business type: If you hold stock, you need to use accrual accounting to track your assets and the cost of goods sold.
• Future plans: Lenders and investors usually want financial reports on an accrual basis. This shows your business’s financial health more clearly.
• Tax requirements: From 2024/25, cash basis is the default unless you choose accrual accounting or are excluded. Speak to a tax professional to check your options.

Cash vs accrual vs hybrid accounting

Performance tracking: Accrual accounting shows true monthly profitability by matching income and expenses to correct periods.

Most businesses choose accrual because it provides better financial insights for decision making.

Technology simplifies accrual accounting

• Automated bill entry: Software reads and records expenses automatically
• Invoice tracking: Records income when you create invoices
• Flexible reporting: Switch between cash and accrual views instantly
• Reduced workload: Automation handles most record-keeping tasks

Xero accounting software makes accrual accounting almost as easy as cash basis while providing much better business insights.

Making the right choice for your business

For a quick look at money in the bank, cash accounting is useful. But for making smart business decisions, accrual accounting gives you the full story. It shows your true profitability and financial position, which is vital for planning and growth.

The good news is you don't have to be an accounting expert to get it right. Using smart accounting software makes it easy to manage your books on an accrual basis, automating much of the work. Xero, for example, can record income when you create an invoice and expenses when bills arrive, giving you real-time insights with less effort.

Ready to see how simple it can be? Try Xero for free and discover a better way to run your business, not just your books.

FAQs on cash versus accrual accounting

Below are answers to common questions about cash and accrual accounting methods.

How do I know if I'm using cash or accrual accounting?

Look at when you record your income and expenses. If you record income only when you receive a payment and expenses only when you pay a bill, you're using cash accounting. If you record them when you earn the income or incur the expense (like when you send an invoice or get a bill), you're using accrual accounting.

Do banks prefer accrual or cash basis accounting?

Most banks and lenders prefer accrual accounting. It shows your business’s financial health over time, including money owed to you and bills you need to pay. This helps them decide on your loan application.

Can I switch from cash to accrual accounting?

Yes, you can switch from cash to accrual accounting. Many businesses do this as they grow. You’ll need to adjust for income and expenses not yet recorded. Work with an accountant to make sure you follow tax rules.