What is Cash Basis accounting in the UK?

Cash accounting or the ‘cash basis’ is a method of accounting that you need to understand if you run a small business in the UK. It’s a fundamentally different approach to accounting aimed at simplifying things for micro businesses and startups. Let’s have a look at what it is and how it could benefit your business.

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What is CASH BASIS accounting? UK small business basics [7]

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All small businesses need to know about ‘cash basis’

When you come to submit your Self Assessment tax return there’s a very important option you need to get right on the return. It fundamentally changes your accounting processes for your business. Sadly most self employed folk don’t even know this exists or what it means. So are you going to use ‘cash basis’? Here’s what the box currently looks like:

Cash Basis - Small Business Toolbox

The ‘cash basis’ is a relatively new method of accounting, introduced by HMRC around 2013-14 to make life simpler for smaller businesses who perhaps don’t have the funds to pay for an accountant to help with traditional accruals-based accounts. In the past there was essentially one option for accounts, although it went under several different names:

  • Traditional Accounting
  • Accruals Based Accounting
  • GAAP Accounting

Cash basis is an alternative to the above and is only applicable to very small businesses run on a self employed basis. It’s only open to businesses making under £150,000 per year turnover (at the time of writing). There’s also an exit threshold of £300,000 per year. This allows you to stay on cash basis even if you pass the £150k. However you then have to change to traditional accounting in the following tax year.

What is Cash Basis accounting?

First of all, cash basis has nothing to do with physical cash! When we talk about ‘cash’ in business we’re normally referring to money that actually exists, as opposed to money you might be owed. So money sitting in your bank account is ‘cash’. Physical cash is obviously ‘cash’ too. But cash doesn’t have to be wad of bank notes – hopefully that makes sense.

The fundamental different between cash basis accounting and traditional accruals-based accounting is that you only account for income and expenditure on the date the money was actually received or spent. This is different from traditional accounting where it’s normally based on the invoice date rather than the date the money left or hit your bank account.

  • Cash Basis: The date on which income was actually received or the date on which expenses were actually paid out.
  • Accruals Basis: The date on which income was invoiced or the date on which you were issued an invoice for expenses, even if no actual money has changed hands yet.

How would Cash Basis impact my business?

If you’re paid immediately for completed work and only buy stuff for your business when you can afford it then cash basis probably won’t impact you at all. When you’re paid on the same day that you asked for the money it effectively means the invoice date is the same as the payment date. Even if no actual invoice changes hands – imagine buying sweets from a sweet shop.

However as your business grows you might start invoicing clients and giving them a certain number of days to cough up. Likewise you might make more use of credit accounts from suppliers. This means you might not have to settle your debts until 30 days from invoice (just as an example).

So let’s look at a scenario where your business has been ticking over nicely but then you receive a huge order for £100,000. You invoice the customer on 5th April 2019 and get paid on 6th April 2019.

  • Traditional Accounting: Your income is classed as being in the 2018/19 tax year and, assuming you had no other income, you’d have a total tax liability of around £33,000 due to HMRC by January 2020 not including any payment(s) on account.
  • Cash Basis: Your income is classed as being in the 2019/20 tax year and, as with above, you’d have a total tax liability of around £32,400 due to HMRC by January 2021.

So in the above example, not only do you pay less tax since you’re working on different tax-free allowances. But you have an extra year to pay the tax too! Now, please don’t take the above example as gospel, I’m not an accountant. However you get the general idea. Paying tax on income that hasn’t actually been received can be crippling for small businesses. The cash basis resolves that issue.

What if I have more than once business?

Good question! You need to pick an accounting method and stick to it across ALL of your businesses. You can’t use Cash Basis for some and Accruals Based for others. Same applies for the income of your businesses. If you operate 2 businesses – one makes £50,000 a year and the other makes £500,000 a year then you’re on traditional accounting for everything I’m afraid. That’s fine though and you should certainly have an accountant at that level anyway.

When might Cash Basis not be for me?

You really need to seek advice from your accountant who will have a much better handle on your individual tax situation, however a couple of things to consider:

High Levels of Stock

If your business carries high levels of stock or you have a more complicated business structure, it might be in your best interests to stay on accruals based accounts. This is definitely a question for your accountant.

Applying for Loans & Mortgages

If you’re applying for loans as a self employed person this can be tricky at the best of times. Normally you want to account for as much income as possible to give the bank a good impression of your business health. So not only might the bank insist on traditional accruals-based accounts anyway but this could also work in your favour as they might based the decision on money invoiced rather than money paid.

Expenses on Bank Charges

If you’re claiming back bank charges as expenses then this could be impacted by cash basis and is certainly something you need to check with your accountant.

Offsetting Losses

You can’t make use of ‘sideways loss relief’ if you’re on Cash Basis. So if you’ve made losses in one business you can’t off-set them against losses of another business. This could have a massive impact on your tax liability and is again something you’d need to check with your accountant.

When should you consider using Cash Basis?

Cash basis is ideal for start-ups, micro-businesses, freelancers and any low turnover business with a very simple business model:

  • Simple business model
  • Don’t owe out money
  • Aren’t owed in money
  • No employees
  • Low stock levels
  • Turnover <£!50k pa

When should you consider using traditional accounting?

More established businesses generally use traditional accruals based accounting practices best suited for:

  • More complex business model
  • Invoice customers
  • Invoiced by suppliers
  • Employ staff
  • High stock levels
  • Need to use Sideways Loss Relief
  • Turnover >£150k pa

Remember, always seek advice from an accounting professional, not some random bloke on the internet. Accountants will have a much better handle on your individual financial affairs and will be able to advise accordingly.

Got any questions? Keep in touch over on Twitter @smallbusinesstb – best of luck!

Photo credit: Colin Watts on Unsplash

Andy Mac

Andy MacLellan has been self employed for over 20 years. In that time he's established a number of successful businesses and worked alongside some of the biggest corporate blue-chips on the planet. Now his life mostly revolves around YouTube and Podcasts.
Andy Mac