This article is relevant to limited companies, not to sole traders.
Have you accidentally slipped into doing your bookkeeping on a cash accounting basis in your Xero or QuickBooks file?
When you’re busy running a company, it’s tempting to take bookkeeping shortcuts to save time. One we see often is the use of “Spend Money” and “Receive Money” in Xero instead of uploading proper bills and invoices. While this might seem harmless, it can lead you into cash accounting territory, which isn’t allowed for limited companies under UK accounting rules, and also means your reporting in Xero won't be very useful.
Here’s a quick explanation of the difference between cash and accrual accounting, and how to make sure you’re staying compliant.
What’s the difference between cash and accrual accounting?
Cash accounting records income and expenses when money actually moves in or out of your bank account. So if you raise an invoice in March but don’t get paid until April, it gets recorded in April.
Accrual accounting (the method companies must use) records income and expenses when they’re earned or incurred, not when money changes hands. That means recognising sales and costs in the right financial period, even if the payment happens at a different point in time.
How using "spend money" and "receive money" in Xero can lead to cash accounting
It’s very common for business owners to go into their bank feed, see a transaction, and click “Spend Money” or “Receive Money” to record it. While this works for certain expenses like bank charges or card fees, it’s not appropriate for most supplier payments or customer receipts.
When you skip creating a bill or sales invoice and just record the cash movement, Xero doesn’t know what period the transaction relates to. It will treat it as if the expense or income occurred when the money left or entered the account, which is exactly how cash accounting works.
Why it matters and how we correct it at year-end
As your accountant, we need to make sure your accounts are prepared on an accruals basis. That means we rely on you uploading your bills and invoices into Xero correctly during the year.
At year-end, we’ll post journals to adjust for things like:
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Unpaid supplier bills (so costs appear in the correct year, even if you pay them later)
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Customer invoices that haven’t been paid yet (so sales are recognised in the right period)
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Prepayments and accruals where needed
But we can only make accurate adjustments if we can see what the original invoice was for, and when it was dated. If all we have is a bank transaction recorded through “Spend Money”, we’re missing critical details.
And a quick note on VAT
To reclaim VAT on your expenses, you must have a valid VAT invoice or receipt that shows the VAT amount and the supplier’s VAT number. If these aren’t uploaded to Xero and properly recorded as bills, HMRC could disallow the VAT reclaim – meaning your business ends up paying more tax than it needs to.
Recording bills properly protects both your accounts and your cash flow.
So how do we avoid falling into cash accounting?
There's a number of things you need to do to ensure you are doing your bookkeeping on the accruals basis, rather than cash accounting...
1. Record supplier invoices and bills properly in Xero - don't use the 'spend money' function
To keep your bookkeeping accurate and compliant with accrual accounting, it's important that bills and sales invoices are recorded correctly – not just entered as bank transactions.
Option 1: Use the ‘Upload Bills’ feature in Xero (quickest and easiest)
This method lets Xero extract the key details from your invoice automatically, saving you time and reducing data entry errors:
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Go to Business > Bills to pay
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Click Upload files at the top right (next to 'New Bill')
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Upload your supplier invoice
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Xero will scan the invoice and pre-fill most of the fields for you
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Review and confirm the details:
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Supplier name
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Invoice date and due date
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Description, amount, account code, and VAT rate
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Click Approve to finalise and post the bill
This is a quick and efficient way to stay on top of your bills. You can also email invoices directly to your Xero files inbox, or use automation tools like Hubdoc or Dext to push them in automatically.
Option 2: Enter a bill manually in Xero
If you prefer or need to enter a bill manually:
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Go to Business > Bills to pay
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Click New Bill
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Fill in the bill details:
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From: supplier name
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Date: invoice date
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Due date: as shown on the invoice
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Reference and description (optional but useful)
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Quantity, unit price, account code, VAT rate
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Attach a copy of the invoice using the paperclip icon
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Click Approve to post the bill
Allocating the payment
Once the bill is recorded, head to your bank feed to match the payment:
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Click into the relevant bank account
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Go to the Reconcile tab
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Xero should automatically suggest a match
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If not, click Find & Match, search for the bill and tick it
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Click OK to reconcile
2. Raise sales invoices in Xero — don’t just record payments
Just like with bills, if you only record incoming payments through “Receive Money” in the bank feed, Xero will treat the income as received when the money hits your account. This means your sales might show in the wrong period, pushing you toward cash accounting.
To avoid this, always create a sales invoice in Xero, even if the customer pays immediately. This ensures your revenue is recognised in the correct accounting period and gives you a clear audit trail.
Step-by-step: How to record a sales invoice in Xero
- Go to Business > Invoices.
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Click New Invoice.
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Enter the customer’s name (create a new contact if needed).
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Fill in the invoice date (the date the sale was made).
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Enter a due date if applicable.
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Add the invoice number or reference (optional but helpful).
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Describe the goods or services sold.
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Enter quantity, unit price, account code, and VAT rate.
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Attach any relevant supporting documents or contracts.
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Click Approve to finalise and send the invoice.
Once the invoice is recorded, when you receive payment, go to your bank feed and match the payment against the invoice under the Reconcile tab to keep everything aligned.
3. Only post bank transactions directly when no invoice exists
Avoid using “Spend Money” or “Receive Money” in Xero for transactions that have supporting invoices or sales documentation. This includes supplier payments, customer receipts, and refunds.
Posting directly from the bank feed should be reserved for genuine exceptions like bank fees, interest, or minor expenses without invoices.
Before posting, always ask yourself: “Is there an invoice or supporting document for this transaction?” If yes, record the bill or sales invoice properly first.
4. Set clear year-end cut-off procedures
To prepare accurate accounts, it’s vital to capture all income earned and expenses incurred in the correct accounting period, even if payments fall outside the year.
Make sure you:
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Collect all outstanding supplier invoices and customer sales invoices around your company’s year-end.
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Record any invoices you receive after year-end that relate to the previous period as accruals.
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Inform us promptly about any income or costs you know relate to the year just ending but are not yet recorded.
This helps us make the necessary journal adjustments and keep your accounts compliant.
By following these steps, alongside recording bills properly, you’ll significantly reduce the risk of unintentionally slipping into cash accounting. It also means your financial reports will be accurate, VAT reclaimed properly, and your year-end process much smoother.
If you’re ever unsure about the correct way to record something, please reach out - we’re here to help you get it right.