Cash basis accounting: Should I be using it for my small business?
Cash basis accounting is ideal for sole traders and partnerships as they are not a complex business structure. The alternative is traditional or accruals accounting, and deciding which is best for your business is important for cash flow purposes. Here we look at whether cash basis accounting is suited to your small business.
Firstly, what is cash basis accounting?
Cash basis accounting is relatively new, first introduced in 2013.
It allows you to account for business transactions as they are happen or in other words, when money actually comes in to your account versus when you invoice a client, which is accrual accounting.
Here is an example of cash basis accounting to help you understand the difference:
You complete a job at the in November 2020 but unfortunately you didn’t get paid until April 2021
You completed the work in tax year 2020-21 tax year but you didn’t get paid until tax year 2021-22
As you didn’t receive the income until the following tax year, you do not need to declare in your 2020-2021 self assessment tax return as the cash wasn’t received until 2021-22.
This means that you are only being taxed on income you have received, not when invoiced for a sale.
Another example of cash basis accounting when it comes to expenses
You buy 20 items to resell in August 2021, but still have 2 left by the end of April 2022
As you paid for the items in August 2021, all 20 items count as an expense for tax year 2021-22.
You would declare the income you have received for 18 items sold and the full cost of the 20 items paid for, as the cash has left your bank account and is a valid business expenses to help reduce your taxable income figure
You would declare the income received on the remaining 2 items only when sold
Can my small business use cash basis accounting?
Not everybody can use cash basis accounting.
If you are a self-employed sole trader or partnership with turnover of less than £150,000 you are eligible to use this accounting method.
If you have more than one business but you are still under the £150,000 turnover threshold, you can use cash basis accounting but you must choose to do so for all your businesses, not just one.
Useful tip:
If you start on cash basis and your business or businesses thrive, you can continue to use the accounting method until your total turnover is over £300,000 a year.
At this point, the next tax return you do will need to be based on accruals accounting.
I am a limited company start-up, can I use cash basis accounting?
Limited companies and limited liability partnerships can’t use cash basis accounting unfortunately.
HMRC has a list of other types of businesses that can’t join the scheme.
Cash basis versus accruals accounting
Cash basis is useful if you are starting out in business and you do not necessarily keep records of invoices you issue, only the usual income and expenses.
For traditional accounting, you must keep a record of:
What you’re owed but haven’t received yet
Expenses you haven’t paid yet
The value of stock and work in progress at the end of your accounting period
Year-end bank balances
How much you’ve invested in the business over the year
Money taken out for personal use
USEFUL TIPS
If you receive more than £500 of bank interest or bank charges in a given year, you cannot use cash basis accounting.
You would also steer away from the simplified cash basis accounting if you are looking for business finance or loan, as a bank or lender will want to see detailed bookkeeping records.
If you also have losses you want to offset against other taxable income, you would not choose cash basis accounting otherwise you cannot get this valuable ‘sideways loss’ relief, which basically allows you to offset any losses against profit for another business you may run
Why cash basis accounting?
Cash basis accounting is ideal for simpler, smaller or start-up businesses that aren’t owed a lot of money or get paid quickly on their sales and also don’t owe a lot of money.
Deciding between traditional accounting or cash basis depends on your business model and structure.
We would be happy to discuss with you in more detail if you are not sure what the best route is for your small business.
