Ask three accountants whether your limited company should use cash basis or traditional accruals accounting and you may get two confident, opposite answers. Both have a point. The catch is that the two methods do different jobs, and one of them is not really on offer to companies at all. Knowing which question you are actually asking saves a lot of time and confusion.

The two methods in plain terms

Traditional accounting, usually called accruals or GAAP accounting, records income when you earn it and costs when you incur them, whatever the bank balance happens to be doing. Invoice a client in March and get paid in May, and the sale belongs to March. Receive a supplier bill for March work that you pay in April, and the cost belongs to March as well. That is why accruals accounts carry debtors, creditors, accruals, prepayments, deferred income and stock.

Cash basis does the opposite. Money is recorded when it moves. A receipt is income on the day it lands; a payment is a cost on the day it leaves. It is far simpler to run, and it tells you exactly what your bank account is doing. What it does not tell you is what you have actually earned.

A quick illustration

Say you raise £40,000 of invoices in March and are paid for £12,000 of them before the year end. Accruals accounts show £40,000 of turnover and a £28,000 debtor. A pure cash record shows £12,000. Both are accurate statements about different things; only one of them is your profit.

What this means for a UK limited company

Corporation tax is charged on profits calculated in line with generally accepted accounting practice. Company law requires statutory accounts to be prepared on an accruals basis, with only narrow exceptions such as dormant companies. The simplifications available to small and micro-entity companies — FRS 105 and FRS 102 Section 1A — change how much you disclose and how you measure certain items, but they remain accruals frameworks. There is no box on the CT600 for cash basis.

In practice, a company can keep its day-to-day records however it likes, including a straightforward cash format, then convert to accruals at the year end. What it cannot do is file accounts or compute corporation tax on a pure cash basis.

One practical consequence: costs incurred but unpaid at the year end must be in the accounts to get tax relief in that period. Leave them out and the deduction simply arrives later. Usually that is a timing point rather than a problem, but it can matter if you are close to a threshold or expecting a loss.

Where cash basis genuinely works for a limited company

Cash thinking has real value inside a company, even when the statutory accounts stay on accruals. The main places it fits:

• VAT Cash Accounting Scheme — account for VAT on your sales when customers pay you rather than when you invoice them. If you are owed a lot of money, this is often the single biggest cash-flow win available to a small company.
• Management accounts and forecasts — a rolling 13-week cash forecast is a cash document. Trying to run liquidity from a profit and loss account is how otherwise healthy businesses run out of money.
• Budgeting and director decisions — "can we afford a new van in June?" is a cash question.
• Unincorporated income elsewhere — if a director runs a sole trade or partnership on the side, the income tax cash basis may apply to that business. Those are separate rules from the company's.

Eligibility and switching rules to know

Thresholds and detail change, so confirm the current position on GOV.UK or with your accountant before you act. The shape of the rules is fairly stable:

• VAT Cash Accounting — open to businesses with taxable turnover at or below the joining threshold (broadly £1.35 million at the time of writing), with a higher exit threshold if turnover grows. You normally have to stay on the scheme for at least a year, and you cannot use it alongside the VAT Flat Rate Scheme.
• Income tax cash basis — available to sole traders and most partnerships, subject to a turnover threshold and an exit test at roughly double that figure.
• Micro-entity accounts (FRS 105) — you must meet two of three size tests covering turnover, balance sheet total and employee numbers. Outgrow them and you move up to FRS 102 Section 1A.
• Switching basis — moving between cash and accruals is a change of accounting policy. Expect a prior period adjustment and, for income tax, transitional rules covering debtors, creditors and stock.

How to decide in practice

1. Ask who reads the numbers. A bank, investor or parent company wants accruals. Nobody lending money is impressed by a cash-only picture.
2. Look at your invoicing pattern. If revenue is seasonal, or a few large contracts land near the year end, cash records will mislead you.
3. Look at how slowly customers pay. Slow payers make the VAT Cash Accounting Scheme worth a proper look.
4. Check whether you hold stock or work in progress. Both distort badly under a cash view.
5. Ask your accountant what they need and when. Many will accept bank-led records each month plus a year-end adjustment list, which keeps the monthly admin light and the compliance correct.
6. Price the change. A scheme switch takes an hour of advice and can save real money; guessing tends to cost more.

A workable approach

Most limited companies end up with a hybrid, and it is a sensible one. Keep clean cash records month by month so you always know your bank position, then let your accountant apply accruals adjustments at the year end for the statutory accounts and the corporation tax computation. Use software with a bank feed, reconcile weekly, and note anything unpaid at the year end — a simple list of accrued costs, prepayments and unpaid invoices is often all that is required.

Avoid switching VAT schemes mid-year on a whim; you cannot hop in and out, and there may be a timing cost. If you are unsure, take advice before you change rather than after. Tax is one area where a short conversation with a qualified accountant is usually cheaper than the correction.

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