What is cash basis accounting?
Cash basis accounting records income when money is actually received and expenses when they are actually paid, rather than when invoices are issued or bills arrive.
What cash basis accounting means
There are two ways to work out business profit. Accrual accounting records income when it is earned and costs when they are incurred, whether or not money has changed hands. Cash basis accounting simply records money in when it arrives and money out when it leaves.
From the 2024/25 tax year, the cash basis is the default for UK sole traders and partnerships of individuals. There is no longer a turnover limit to use it. You can opt out and use accruals instead. Limited companies and LLPs cannot use the cash basis for tax; they must use accruals.
Example
A self-employed photographer has a 5 April year end. In March she shoots a wedding and invoices £2,400, which the couple pay on 20 April. She also buys a £1,800 camera lens in March but pays for it in April on interest-free terms.
| Cash basis (this year) | Accruals basis (this year) | |
|---|---|---|
| Wedding income | £0 (received next year) | £2,400 |
| Lens cost | £0 (paid next year) | Capital allowances on £1,800 |
Under the cash basis both items fall into next year. The photographer pays tax only on money she has actually received.
Why it matters for your business
The cash basis is simpler. There are no debtors, accruals or prepayments to calculate, and you never pay tax on income you have not yet received. Most equipment, apart from cars, is simply deducted when paid for rather than through capital allowances.
It is less suitable if you hold significant stock, give long credit terms, or want to borrow, because lenders may prefer accruals-based accounts. Losses are also more restricted under the cash basis in some situations. Businesses heading towards incorporation may prefer accruals so their figures compare like for like.
Cash basis vs VAT cash accounting
They are different things. The cash basis is for working out profit for income tax. The VAT cash accounting scheme decides when you pay VAT and has its own turnover limit. You can use one, both or neither.
With Making Tax Digital for Income Tax, both cash basis and accruals users must keep digital records and send quarterly updates once they are within the scheme.
Common questions
No. It is the default from 2024/25, but you can opt out on your tax return and use accruals accounting instead. Some businesses with large stock or long payment terms find accruals gives a fairer profit figure.
No. Limited companies and LLPs must prepare accruals-based accounts for Companies House and Corporation Tax. A company can still use the VAT cash accounting scheme if it qualifies. This is one reason incorporating adds some bookkeeping work.
More accounts & bookkeeping terms
- Accounting equation
- Accounts payable
- Accounts receivable
- Accruals
- Amortisation
- Assets
- Bad debt
- Balance sheet