Sole traders & Partnerships: You can now choose cash basis, will it save you money?
You may have missed the announcement at the Autumn Budget that sole traders and partnerships now have the option to report on a cash basis versus accrual basis, no matter their level of turnover.
Firstly, it is important to understand the difference between cash basis and accrual basis accounting, read here for a summary.
Is Cash Basis right for me?
You do have the option to decide whether you use the cash or accrual basis to manage your business, and the idea of moving to cash basis on the face it could mean simplifying your reporting to HMRC. However, cash basis may not work for all types of businesses, because as an individual, you also report on other income on your self assessment tax return, and each year you may have your business income plus other income to consider to determine how much tax you will pay that year.
For example say you receive a sale for a product or service. Perhaps delivering this product or service to your client involves some time, and you may not incur the expenses relating to creating that product or service in the tax year when you received the sale income. In this example, you would need to declare the income as a sale in the current tax year, but the tax relief relating to the expenses to deliver the sale are not recognised until the following tax year.
Timing is therefore everything.
Conversely, you may incur expenses in a given tax year, but if you have invoiced and not received the income in the current tax year, perhaps due to a delay in receiving payment from a client or invoicing close to tax year-end, then your profit and loss could be very different year to year, which could cause issues with securing a loan or getting a mortgage personally, with explanations required to explain fluctuations in profit year to year. This could be unhelpful also from a business management perspective when trying to understand how your business is performing, cash flow analysis and budgeting.
What are the benefits of using the cash basis in my business?
There is not doubt that we agree with the government’s stance that using the cash basis is simpler from an accounting perspective and indeed, when Making Tax Digital is in force from April 2026, reporting quarterly to HMRC via cash basis will be much easier than using the accrual basis.
If you are a business that struggles to find allowable business expenses, perhaps delivering a service that requires little to no overheads to generate sales, cash basis may be an attractive option. For example, if you manage your numbers throughout the tax year and can see you are close to breaching a higher income tax band towards the end of a tax year, you could ask clients to pay you in the following tax year. This will help to keep your tax liabilities at the lower income tax band in both the current and future tax year, if the expenses are similar in both years.
If you sell a product, you may want to to pay supplier invoices before tax-year end to help reduce your overall taxable profits, cash flow permitting.
Where a business has a substantial chunk of unrelieved capital allowances sitting in the main pool, switching to the cash basis would see the whole amount released as an expense in the transition year, significantly reducing the tax bill that year.
What next?
It is important to recognise that every business faces unique challenges and making a decision on whether to use cash basis will require careful consideration between you and your adviser to ensure you are operating both compliantly and tax efficiently. Please get in touch if you are looking for proactive, tailored advice.
