Every self-employed person in the UK must choose an accounting method for their tax return. The two options — cash basis and accrual (traditional) accounting — affect when you report income and expenses, which directly impacts your tax bill.
Cash Basis Explained
Cash basis is the simpler method. You record:
- Income when the money hits your bank account
- Expenses when you actually pay them
If you invoice a client in March but get paid in May, the income counts in May. If you buy a laptop in February but pay the credit card in March, the expense counts in March.
Who Can Use Cash Basis
Since April 2024, cash basis is the default method for sole traders and partnerships. You’re automatically on cash basis unless you choose to opt out.
Eligibility rules:
- Gross self-employed income up to £150,000 per year
- Must be a sole trader or partnership (not a limited company)
- Cannot be a Lloyd’s underwriter
- Cannot use farming or creative averaging elections alongside cash basis
Advantages
- Simpler bookkeeping — no need to track who owes you or what you owe
- Tax timing benefit — you don’t pay tax on invoices until you’re paid
- Bad debts handled automatically — if a client never pays, you were never taxed on it
- No complex year-end adjustments — what you received and spent is your profit
Limitations
- Loan interest restrictions — you can only deduct up to £500 of interest on business loans
- No loss carry-back — losses under cash basis can only be carried forward, not offset against other income or carried back to previous years
- Limited capital allowance claims — you can’t claim capital allowances on most assets (but can deduct the full purchase cost when you pay)
- Less accurate profitability picture — if you have large outstanding invoices, your accounts won’t reflect true business performance
Accrual (Traditional) Accounting Explained
Accrual accounting matches income and expenses to the period they relate to, regardless of when cash moves. You record:
- Income when you earn it (when you invoice or deliver the service)
- Expenses when you incur them (when you receive the bill or goods)
If you invoice a client in March 2027, that income appears on your 2026/27 tax return — even if payment doesn’t arrive until June 2027.
Who Must Use Accrual
You must use accrual accounting if:
- Your gross income exceeds £150,000
- You run a limited company (always uses accrual)
- You want to claim capital allowances (including annual investment allowance)
- You have significant business loans with interest over £500
- You want to carry losses back to previous years
Advantages
- Full interest deductions — no £500 cap on business loan interest
- Capital allowances available — claim annual investment allowance on equipment, vehicles, machinery
- Flexible loss relief — carry losses back to offset against previous year’s tax, or against other income
- True business picture — your accounts reflect actual business performance including costs and debts owed to you
- Better for stock-heavy businesses — properly accounts for inventory purchased but not yet sold
Disadvantages
- More complex bookkeeping — must track debtors, creditors, prepayments, and accruals
- Tax on unpaid invoices — you may owe tax on income you haven’t actually received yet
- Bad debt claims required — if a client doesn’t pay, you must formally write off the debt to reclaim the tax
- Year-end adjustments — need to calculate what’s owed at year end
Side-by-Side Comparison
| Factor | Cash Basis | Accrual |
|---|---|---|
| Income recorded | When received | When invoiced |
| Expenses recorded | When paid | When incurred |
| Complexity | Simple | More complex |
| Income threshold | Up to £150,000 | No limit |
| Loan interest deduction | Capped at £500 | Unlimited |
| Capital allowances | Not available (but full cost deductible) | Full capital allowances |
| Loss relief | Carry forward only | Carry forward, carry back, or offset |
| Bad debts | Automatic (never recorded) | Must be written off formally |
| Best for | Simple service businesses | Stock businesses, higher earners, those with loans |
Which Method Should You Choose?
Choose Cash Basis If
- You’re a freelancer, consultant, or service provider with straightforward invoicing
- Your income is under £150,000
- You don’t carry stock
- You want the simplest possible bookkeeping
- You don’t have significant business loans
- Most of your clients pay within a reasonable timeframe
Choose Accrual If
- Your income exceeds or approaches £150,000
- You carry stock or inventory
- You have business loans with interest over £500 per year
- You want to claim capital allowances (e.g., on a vehicle or expensive equipment)
- You want flexibility in how you use business losses
- You have long payment terms and want your accounts to reflect true performance
How to Switch Methods
Cash to Accrual
When switching from cash basis to accrual, you’ll need transitional adjustments:
- Add outstanding income — invoices sent but not yet paid on the transition date become income in the new period
- Add outstanding expenses — bills received but not yet paid become deductible expenses
- Report adjustments on your Self Assessment — use the notes section to explain the transition
Accrual to Cash
Switching to cash basis is simpler because HMRC’s default is now cash basis. However:
- Remove debtors and creditors from your records
- Don’t double-count — income already reported under accrual shouldn’t be reported again when received
- Check stock position — stock purchased under accrual and sold under cash basis needs careful handling
Practical Tip
Switching mid-stream can create complications. If possible, switch at the start of a tax year and have an accountant review the transition to prevent double-counting or missed income.
Making Tax Digital Implications
Both accounting methods are compatible with Making Tax Digital (MTD) for Income Tax. From April 2026:
- Sole traders with income over £50,000 must submit quarterly digital updates
- The threshold drops to £30,000 from April 2027
MTD-compatible software handles both cash and accrual methods. The quarterly reporting simply reflects whichever method you’re using.
When to Get Professional Advice
While cash basis is designed to be simple enough to manage yourself, consider an accountant if:
- You’re near the £150,000 threshold
- You’re unsure whether capital allowances or full cost deduction saves you more
- You’re switching methods and need transitional calculations
- You have both employed and self-employed income with business losses
- You carry significant stock or work-in-progress
An accountant typically costs £200–£500 per year for simple sole trader accounts — often saving more than their fee in optimised tax treatment.