Understanding cash basis accounting: A simple guide

In accounting methodology there are two approaches to preparing business accounts in the UK: 

• Accruals basis / UK GAAP accounting 
• Cash basis 

Until recently, not everyone could use the cash basis for accounting. This meant a lot of businesses did not prepare their accounts in this way. Following the easing of the restrictions, many businesses will be considering what it is, should they use it and how does it work. 

Read our comprehensive guide into the cash basis for accounting for unincorporated businesses. Our guide includes practical examples to help you know where you stand. 

What is cash basis accounting? 

Cash basis accounting is recording income and expenses when they are paid and received. In contrast, accruals accounting is recording income and expenses when they are incurred. For example, invoice/bill date, regardless of when they are paid and received. 

Small businesses may want to take advantage of using this method as it is a straightforward way of preparing accounts. 

Choosing the right method of accounting for your business is important. Consider the overall picture and how you plan to use your accounts to determine the most effective approach.  

Key features of cash basis accounting 

• Income recognition: Income is recorded only when cash is received from customers. 
• Expense recognition: Expenses are recorded only when cash is paid to suppliers or for business costs. 
• Simplified bookkeeping and reporting: Cash basis accounting simplifies bookkeeping. 
• Capital assets: Under cash basis accounting, the cost of capital equipment is usually included in the accounts as an expense. Assets purchased and reported under the accruals basis are not included in the profit and loss account. Instead, they are included as capital allowances. A person using the cash basis is not entitled to claim capital allowances. 

Should I use cash accounting? 

With the removal of the restrictions, the cash basis is open to most businesses. The method is simpler but that doesn’t necessarily mean it’s suitable for your business. 

Advantages of cash basis accounting 

1. Only pay tax on income received: Accounting for income on a cash basis means you only pay tax on income that’s been received. This is particularly beneficial to businesses who have a high level of debtors, or have slow paying customers. 
2. Simplified accounts: When using the cash basis, your annual accounts will require fewer accounting adjustments. For example, there’ll be no requirement to include accruals, prepayments and so on. This will save you time, particularly for businesses reporting quarterly under Making Tax Digital (MTD). 
3. Alignment with cash flow tracking: Accounting for income and expenses on a cash basis allows direct monitoring of cash inflows and outflows. This can assist businesses particularly susceptible to cash flows, for example those that are growing and have large spends. 

Disadvantages of cash basis accounting 

1. Limited picture of financial health: Accounts without debtors and creditors may not provide a complete picture of a business’ financial health, and position. Businesses that are not so straightforward may need accruals basis accounting to enable them to make appropriate business decisions. 
2. Difficulty attracting investors: When accessing funding and financial assistance, such as loans and mortgages, accounts prepared under the cash basis may not be an acceptable method as they lack certain details required. 
3. Not suitable for complex businesses: Cash basis accounting may not be appropriate for businesses with significant inventory, accounts receivable, or payable. 

How to implement cash basis accounting 

Reporting 

Recent changes have meant that from 2024/25 tax year, the cash basis is the default method of accounting. If you used the cash basis for the 2023/24 tax year, you will need to tick a box to say so on your self-assessment tax return. For 2024/25, you no longer have to tick a box on your tax return, in fact you need to do nothing to tell HMRC you have used the cash basis! 

Adjustments 

For businesses that have previously used the accruals basis, on the first set of accounts you’ll need to make some adjustments. This includes removing all the previous accounting adjustments that took place under accruals accounting. 

If you do not complete these adjustments successfully, there may be some duplication in the accounts. For example, not removing debtors previously provided for would result in income being taxed twice. Seek professional help to ensure this technical process is properly carried out. 

How we can help 

Our accountants are experts and can advise you on which accounting method is most suitable for your business. Once decided, we can carry out bookkeeping to your requirements as well as your accounts and tax return. Give our friendly team a call today on 0800 0523 555 or use our online contact form. 

FAQs 

Can I switch between cash basis and accrual basis accounting?  

Yes, you can change your accounting method, but you must inform HMRC. You must then follow transitional procedures to make sure you account for all your income and expenses only once. You may need to seek expert help when transitioning between methods. 

Is cash basis accounting suitable for all small businesses?  

Cash basis accounting is particularly beneficial for many small businesses, as it makes accounting simpler. It may not be appropriate for those with complex transactions, significant inventory, or a need for detailed financial reporting. 

Date published 29 May 2024 | Last updated 20 Jun 2024

This article is intended to inform rather than advise and is based on legislation and practice at the time. Taxpayer’s circumstances do vary and if you feel that the information provided is beneficial it is important that you contact us before implementation. If you take, or do not take action as a result of reading this article, before receiving our written endorsement, we will accept no responsibility for any financial loss incurred.

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