Cash basis vs accrual accounting for Making Tax Digital IT

Choosing between cash basis and accrual accounting can affect how income and expenses are reported throughout the year under Making Tax Digital for Income Tax. This guide explains the differences and how TaxNav supports both approaches.

Making Tax Digital for Income Tax (MTD IT) is now live, and for many self-employed people and those with property income, the focus has understandably been on digital record-keeping and the quarterly year-to-date submissions of their income and expenses to HMRC.

But there’s another important change sitting underneath it all: cash basis accounting is now HMRC’s default method for calculating trading profits for sole traders and partnerships.

That means many people who previously used traditional accrual accounting methods may now find themselves on cash basis unless they actively choose otherwise. So what’s the difference, and which option is right for your business?

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What’s the difference between cash basis and accrual accounting?

The difference comes down to when income and expenses are recorded.

Cash basis

With cash basis accounting, income is recorded when money is actually received and expenses when they are paid. For example:

  • If you invoice a client in March but they pay you in May, the income is recorded in May.
  • If you receive a supplier bill in June but don’t pay it until July, the expense is recorded in July.

For many sole traders, this feels the most natural way to work because it reflects the money actually moving through the bank account.

Accrual accounting

Accrual accounting works differently. Income is recorded when it is earned, and expenses when they are incurred, regardless of when payment happens. Using the same example:

  • An invoice raised in March is recorded in March, even if the client pays in May.
  • An expense relating to March is included in March’s figures, even if the bill is paid later.

This approach is often used by larger or more complex businesses because it gives a more complete picture of profitability during a period.

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Why does this matter more under MTD IT?

Under the old Self Assessment system, your accounting method mainly affected one annual tax return.

Under MTD IT, you are now submitting four year-to-date updates of your income and expense totals throughout the year, so the accounting basis shapes your figures far more regularly.

For many businesses, the cash basis fits naturally with quarterly reporting because the updates can largely follow money in and money out during the quarter.  It also means you generally avoid dealing with accruals adjustments, prepayments and unpaid invoices during the year.

Accrual accounting can still be the right choice, but it usually requires more year-end adjustments before the Final Declaration is submitted.

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Why HMRC made cash basis the default

Cash basis used to come with certain restrictions, but HMRC relaxed many of these from the 2024/25 tax year onwards. For example:

  • the old turnover limits were removed
  • restrictions around interest deductions were relaxed
  • loss relief rules were aligned more closely with accrual accounting

As a result, cash basis is now a much more practical option for a wider range of businesses, which is why HMRC made it the default approach. Find out more at HMRC’s cash basis page.

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Which method is right for you?

There isn’t one universal answer. It depends on how your business operates.

Cash basis may suit you if:

  • you want the simplest possible approach to MTD IT
  • your customers generally pay you reasonably quickly
  • you work mainly from your banking and credit card transactions
  • you don’t hold significant stock
  • you want quarterly updates to stay straightforward

Accrual accounting may suit you if:

  • you work with long payment terms
  • you need a more detailed profitability view
  • you hold stock or work in progress
  • you produce accounts for lenders or finance applications
  • your accountant advises it for your circumstances

For many self-employed individuals such as freelancers, consultants, tradespeople, along with landlords and those with property rental income, cash basis is likely to feel simpler and more aligned to how they already manage their finances.

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Can you switch between the two?

Yes. The choice is made each tax year. However, switching between cash basis and accrual accounting can create transitional adjustments to avoid income or expenses being missed or counted twice.

This is particularly important where unpaid invoices, stock or work in progress are involved. If you are thinking about changing accounting basis, it is usually worth speaking to your accountant first.

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How TaxNav helps

TaxNav is HMRC-recognised MTD IT software built specifically for UK self-employed people and those with property rental income who fall within Making Tax Digital for Income Tax’s scope. It’s designed to keep quarterly digital record-keeping and quarterly update reporting simple, whichever accounting method you use.

With TaxNav you can:

  1. Choose cash basis or accrual accounting to match the method you’ve elected with HMRC
  2. Work to standard HMRC quarter dates or calendar quarters, depending on what best fits your bookkeeping rhythm
  3. Keep categorised and consolidated expenses organised in one place, ready for quarterly submissions
  4. See a running estimate of your tax position through the year as each update is submitted
  5. Complete your Final Declaration in the same system used for your quarterly updates
  6. Continue working with spreadsheets through bridging support for Excel, Google Sheets and Apple Numbers

Most importantly, MTD IT doesn’t have to mean abandoning the way you already work. TaxNav is designed to support straightforward digital compliance without forcing sole traders and landlords into complex bookkeeping software.

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Final thoughts

Now that MTD IT is live, understanding whether you use cash basis or accrual accounting matters more than it used to. For many smaller businesses, HMRC’s move to cash basis as the default will make quarterly reporting simpler and more manageable.

Whichever method you use, TaxNav is designed to keep MTD IT straightforward. There’s a 30-day free trial, with subscriptions available at £60 + VAT annually or £6 + VAT monthly pay as you go.

Whether you prefer direct entry or working from spreadsheets, TaxNav helps you stay compliant without changing the way you already work.

Find out more and get started at taxnav.digital

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