What is accrual accounting?
Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when the money is actually received or paid.
What accrual accounting means
Under accrual accounting, a sale counts on the date you deliver the goods or complete the work, even if the customer pays two months later. A cost counts when you receive the goods or service, even if you have not paid the bill. The cash timing is tracked separately through accounts receivable and accounts payable.
Adjustments such as accruals, prepayments and deferred income make sure income and costs land in the period they belong to. This is the matching principle.
Who must use it
All UK limited companies and LLPs must prepare accounts on the accruals basis. Sole traders and most partnerships can choose: since April 2024 the cash basis has been the default for income tax, with no turnover limit, but they can opt out and use accruals instead.
Example
A freelance developer invoices a client £6,000 on 20 March for work done in March. The client pays on 25 April. Her tax year ends on 5 April.
| Method | Income for the year to 5 April |
|---|---|
| Accruals basis | £6,000 (earned in March) |
| Cash basis | £0 (received in April, next tax year) |
On the cash basis she pays tax on it a year later. On the accruals basis her accounts show the true income for the year, which matters if she is applying for a mortgage or comparing years.
Why it matters for your business
Accrual accounting gives a far more accurate picture of performance. A business that invoices heavily in one month and collects the next would otherwise show wild swings. It also lets you see what you are owed and what you owe at any moment, which is essential for managing cash flow, and it is what lenders and investors expect to see.
Accrual vs cash basis
The cash basis is simpler and often suits small sole traders whose customers pay straight away. Accruals suit businesses that invoice on credit, hold stock or want to claim losses more flexibly. The choice can change when tax is paid, so it is worth reviewing as a business grows or before incorporating.
What it takes
Accrual accounting needs invoices and bills recorded as they happen, plus month-end adjustments. Cloud software makes this routine.
Common questions
If you run a limited company or LLP, yes. If you are a sole trader or in a partnership, the cash basis is the default for tax since April 2024, but you can choose the accruals basis instead if it suits your business better.
It can. Income is taxed when earned, so an invoice raised before the year end is taxable that year even if unpaid. If a customer never pays, the debt can be written off as a bad debt, which reduces taxable profit.