Learn the differences between accrual accounting and cash basis accounting in the UK to understand which is best for your business’s finances.
Cash Accounting
The cash basis accounting method is when a business records the income and expenses when things have been paid for. There is no credit, everything is recorded when money comes into a business account or when expenses leave the account.
For example, if your business bought a car with a loan in June and paid the entire loan back in July, you would only record the money leaving your account in July.
Some think the cash method is simple, but there are downsides, like forgetting to pay a bill because it doesn’t show up under accounts payable. The cash system would only record when the bill is paid for.
When to use cash basis accounting
Some companies benefit from using the cash method:
- Companies without inventory: Businesses need to log their inventory at the opening and closing of the tax year. This can be problematic with cash basis accounting because it records the cash ins and outs, not the inventory. So, if your business doesn’t have inventory or is small enough to monitor easily, then cash accounting should work.
- Small businesses and sole owners: For a small business, cash basis accounting can work because it is simple to use. Also, the HMRC cap of £150,000 per annum earned means a small business doesn’t need to use accrual accounting for monitoring cash flow.
- Cash-only businesses: While not very common, cash-only businesses do still exist, where electronic banking is not accepted. This means that cash-only businesses don’t need to deal with credit-related liabilities. However, they need to keep all the cash receipts to keep track of cash flow.
Accrual Accounting
In accrual accounting, the expenses and income get recorded when they are earned and billed. It doesn’t matter when the money comes in or goes out, it’s recorded to keep an up-to-date analysis of what is to come.
The Generally Accepted Accounting Practice (GAAP) approves the use of accrual accounting as it provides a much better forecast of a company’s financial health.
It’s easy to see why – because cash accounting doesn’t account for anything happening in the future financially. This can cause an issue for businesses trying to paint an accurate picture of where they are and where they’re headed financially.
When to use the accrual basis accounting
The accrual method is generally used by larger companies that have too many expenses and income transactions for a cash-only accounting method.
Here are some examples of when the accrual accounting method is best:
- Tracking liabilities and assets: The accrual method provides a more detailed overview of assets and liabilities. Since everything is recorded as it happens, the accounts are up to date, allowing companies to see what is happening for the overall financials. Businesses can track their assets and liabilities to ensure financial stability in the future.
- Working with credit: If a business uses any type of credit, accrual accounting is vital for financial management. Credit transactions can sometimes take weeks to hit a business account, which may impact the debits and credits depending on the timeframe. Plus, up-to-date recording of money owed leaves less chance of missing payment dates.
Is Cash or Accrual Basis Accounting Better for Taxes?
Small businesses prefer cash-based accounting as it is simple to use come the time to pay taxes. However, the accrual system is better for companies that need accuracy when declaring yearly revenue.
Is the cash-basis method GAAP compliant?
No, the cash basis system does not comply with GAAP standards.
Our Final Thoughts on Cash and Accrual Accounting
Choosing which accounting method to use for a business can be daunting if you don’t understand where your company fits. There is a fine line between your company being large enough to warrant accrual accounting or small enough to use a cash basis system.
It’s always best to consult an accountant before making your final decision. An accountant won’t only help make the choice but can also offer advice on why you should choose one over the other.
Sources:
https://www.forbes.com/advisor/business/cash-vs-accrual-accounting/
https://quickbooks.intuit.com/accounting/cash-vs-accrual-accounting-whats-best-small-business/
https://www.sage.com/en-gb/blog/cash-and-accrual-accounting/amp/