Cash vs accrual accounting: which basis should you use

Cash-basis accounting

On the cash basis you record income when you receive it and costs when you pay them. It is simple and mirrors your bank account, which is why the smallest unincorporated businesses can use it. But it can distort profit — a big invoice unpaid at year end simply does not show up.

Accrual-basis accounting

Accrual accounting records income when it is earned and costs when they are incurred, regardless of when cash moves. A sale counts when you deliver, not when you are paid; a cost counts when you receive the benefit, matched to the period it relates to. This is why accruals and prepayments exist.

Why companies use accrual

Limited companies must generally prepare accounts on the accrual basis under UK accounting standards. It gives a truer picture of performance by matching income to the costs that earned it — the matching principle. It is also why a profitable company can still be short of cash: profit and cash are not the same thing.

The practical consequence

Because accrual profit differs from cash in the bank, you must manage both. Your profit and loss shows accrual profit; your cash-flow statement shows the cash. Directors who watch only one get caught out.

Managing the gap

The gap between earning profit and collecting cash is exactly where working-capital finance lives — bridging the wait between the sale and the payment.

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