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If you’re starting up your business, then there are plenty of decisions to make. One of these is whether to use cash-basis or traditional accrual basis accounting. An accountant will advise you which is the best method for your particular business, but having an understanding doesn’t hurt!
 

What is traditional accrual accounting?

What is cash basis accounting?

Who can use cash basis accounting?

The accrual method of accounting, sometimes also known as traditional accounting or accrual basis, means you must include every single invoice you send and receive when you work out your tax return, whether it’s been paid or not.

This also means that you’ll pay tax on the income you expect to receive from an invoice, even if the customer hasn’t paid it yet. As accountants like to joke, “it’s accrual world”.

An example of traditional accrual accounting

You invoice a customer at the end of March 2023 (the 2022/23 tax year). They don’t pay you until May 2023 (the 2023/24 tax year). The invoice is recorded in the 2022 to 2023 tax year accounts, rather than 2023/24.

Traditional accounting requires you to keep records of all income and expenditure, such as:

Traditional accounting generally suits larger businesses, but it’s worth considering – especially if you predict quick growth for your business.
 

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Unlike traditional accounting, businesses using cash basis accounting only include invoices and expenses in their tax return once they’re actually paid. This means you can’t claim an expense until you’ve paid the bill, but it also means that you won’t pay tax on any invoices until your customer pays you.

An example of cash basis accounting

You invoice a customer at the end of March 2023 (the 2022/23 tax year). They don’t pay you until May 2023 (the 2023/24 tax year). The invoice is recorded in the 2023 to 2024 tax year accounts, rather than 2022/23.

The treatment of some items is different, depending on which type of accounting you use. For example;

Cash basis accounting is generally more suitable for smaller sole trader businesses with a turnover less than £150,000. You can continue using cash basis accounting as your business grows, up to a total business turnover of £300,000 per year. If you reach the threshold then you’ll need to use the traditional accrual basis of accounting on your next tax return.

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About The Author

Beth-Anne Bruce

I'm an experienced and fully AAT and ACCA qualified accountant, who is enthusiastic about helping business owners succeed. I also love cooking and needlepoint (at different times!). Learn more about Beth.

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