What is cash basis accounting and can I use it for my small business?

Small businesses might find that cash basis accounting is a more straightforward way to manage their finances than traditional accounting.

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Sole traders and partnerships can use cash basis accounting, which is particularly suited to businesses that don’t have a complicated setup.

Deciding whether to use traditional accounting or cash basis needn’t be tricky – find out what you need to know here.

What is cash basis accounting?

Cash basis accounting is relatively new – HMRC introduced it in 2013-14. The system lets you do your taxes based on when money actually comes in (and leaves) your business.

This is different to traditional (accruals) accounting, which is based on when you do the work and raise the invoice, rather than when you receive the cash.

Here’s a cash basis accounting example for income...:

• you complete a job at the in February 2021, but unfortunately don’t get paid until 12 April 2021
• while you did the work in the 2020-21 tax year, you didn’t get paid until 2021-22
• the money counts as income for 2021-22, meaning it doesn’t go on your next tax return

...and a cash basis accounting example for expenses:

• you buy 10 items to resell in August 2021, but still have two left by 6 April 2022
• as you paid in August 2021, all 10 items count as an expense for tax year 2021-22
• there’s no stock asset left at year end

Can my small business use cash basis accounting?

There are rules about who can and can’t use cash basis accounting. You have to:

• be a self-employed sole trader or partnership running a small business with less than £150,000 turnover a year

If you have more than one business, you have to use cash basis accounting for all of them – and you can’t earn more than a combined turnover of £150,000.

And what if your business is doing well and makes more money throughout the year? You can stay in the scheme up to a turnover of £300,000 a year – after which you’ll need to use traditional accounting for your next tax return.

Limited companies and limited liability partnerships can’t use cash basis accounting, and HMRC has a list of other types of businesses that can’t join (these are niche, though, including waste disposal and ministers of religion).

Play on YouTube: What is business turnover and how do you work it out?

Cash basis vs traditional accounting

Cash basis is simpler than traditional accounting, because you don’t need to keep other records on top of your income and expenses.

On top of the usual tax records you need to keep, when using traditional accounting on your tax return you need to show:

• 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

But gov.uk calls out a number of reasons why cash basis accounting might not suit your business, for example if you:

• want to claim interest or bank charges of more than £500 as a business expense (you can’t claim more than this using cash basis)
• have a complicated setup (if you have lots of stock, for example)
• are looking for finance – a bank might ask to see what you’re owed and are due using traditional accounting
• have losses you want to offset against other taxable income (sideways loss relief – offsetting losses against another business you run)

This means that cash basis accounting is ideal for simpler, smaller businesses that aren’t owed a lot of money (and don’t owe a lot of money).

Ultimately deciding between traditional accounting or cash basis depends on your setup, so it’s best to speak to a professional accountant or legal adviser if you’re not sure.