Cash Basis vs Traditional Accounting? Choose the right one for your Business

Cash Basis vs Traditional Accounting? Choose the right one for your Business

Cash basis or traditional accounting? If you are run a small business in the UK, it’s important you know the differences and choose the right accounting system for your business.

Self-Employed (Sole Traders) individuals in the UK are required to submit a Self-Assessment Tax Return to HMRC to declare the income for the year. But how are profits calculated and also very importantly, for which period are business income and expenses declared?

For example, a business purchases material and equipment on credit 15 March 2021, but actually pays a month later on, for example, 15 April 2021. Now, the question arises, for which period or tax year (2020-21 or 2021/22?) is the business expense going to be declared in the Self-Assessment Tax Return?

In this blog, we will explore the differences between cash basis and tradional accounting and which one is more suitable for your business.

There are two methods a Sole Trader can use to record the business income and expenditures,

  • Cash Basis (or Cash accounting)
  • Traditional Accounting (also known as Accrual basis)
cash basis
Cash Accounting is the most common method used by smaller businesses

Cash Basis

Cash basis is the most common method used by smaller businesses. As the name suggests, transactions are recorded for the period only when cash is paid or received. For example, you invoice a client on 1 January 2021, but the client pays on 3 March 2021. This transactions will be recorded using the payment date, i.e. 3 March 2021.

Who can’t use the scheme

Most Self-Employed and small businesses can use the cash accounting. However, limited companies and limited liability partnerships can’t use cash basis. There are also some specific types of businesses that can’t use the scheme:

  • Lloyd’s underwriters
  • farming businesses with a current herd basis election
  • businesses that have claimed business premises renovation allowance
  • businesses that carry on a mineral extraction trade
  • businesses that have claimed research and development allowance
  • dealers in securities
  • ministers of religion
  • pool betting duty
  • managed service companies
  • waste disposal
  • cemeteries and crematoria

See the full list here: Who can’t use Cash Accounting

Cash Basis Examples – Invoicing

So how does it work? Here are some examples for invoicing clients or customers:

Invoice DatePayment Received DateRecorded in the booksRecorded for Tax Year
01/01/202103/03/202103/03/20212020/21
15/03/202115/05/202115/05/20212021/22
01/04/202107/04/202107/04/20212021/22
20/06/2021n/a*
28/12/202104/05/202204/05/222022/23
Transactions are recorded only when payment is received or payment is made

*If you invoice a client but the money is never received, it wil not be recorded in the books using the cash basis and declared in the Self-Assessment Tax Return. So if you use the cash basis of accounting, you won’t have to pay income tax and NIC on income you didn’t receive in the tax year.

Disadvantages of Cash Basis

Cash basis can not be used for business with more than £150,000 of turnover. For businesses with over £150,000 annual turnover, the traditional accounting method needs to be used. So as long as the turnover is less than £150,000 you can use a cash basis, however there are instances when it’s not ideal to use cash basis for your business:

  • want to claim interest or bank charges of more than £500 as an expense
  • run a business that’s more complex, for example you have high levels of stock
  • need to get finance for your business – a bank could ask to see accounts drawn up using traditional accounting to see what you owe and are due before agreeing a loan
  • have losses that you want to offset against other taxable income (‘sideways loss relief’)

The Simplified Expenses Scheme

If you choose Cash basis, you can use Simplified Expenses Scheme to calculate some of your business expenses using flat rate. This is only applies if you choose Cash basis, as this scheme can not be used if you use Traditional accounting!

Simplified Expenses Scheme – Flat rates:

  • your car (mileage allowance)
  • working from home (home office allowance)

For all other business expenditure, just work them out as you would normally.

Traditional Accounting

Using the traditional acocunting system transactions are recorded using the invoice date and reported for the tax period to which it relates. Traditonal accounting is generally more complex than cash accounting, however larger businesses can benefit from tradtional accounting, for example, if a business keeps large amount of stock or need to file VAT returns, then this accounting system can be more beneficial.

Traditional Accounting Examples – Invoicing

Invoice DatePayment Received DateRecorded in the booksRecorded for Tax Year
01/01/202103/03/20211/01/20212020/21
15/03/202115/05/202115/03/20212020/21
01/04/202107/04/202101/04/20212020/21
20/06/2021n/a*20/06/20212021/22
28/12/202104/05/202228/12/20212021/22
Transactions are recorded using the invoice date

VAT Registered Businesses

Traditional accounting is generally more complex than cash accounting, however larger businesses can benefit from tradtional accounting, for example, if a business keeps large amount of stock or need to file VAT returns, then this accounting system can be more beneficial.

cash basis

VAT Registered – Cash Basis

Accounting MethodInvoice DatePayment DateVAT Quarter Ending 31 March 2021VAT Quarter Ending 30 June 2021
Cash Basis28/02/202115/04/2021
Cash Basis28/02/202115/04/2021
Cash Basis03/03/202103/05/2021
In this example, using the Cash basis, a business can not claim for stock purchased for the Quarter Ending 31 March 2021

VAT Registered – Traditional Accounting

Accounting MethodInvoice DatePayment DateVAT Quarter Ending 31 March 2021VAT Quarter Ending 30 June 2021
Traditional 28/02/202115/04/2021
Traditional28/02/202115/04/2021
Traditional03/03/202103/05/2021
However, uing the Traditional accounting, a business can claim the VAT on the stock for the quarter ending 31 March 2021

Record Keeping

Traditonal accounting is generally more complex than cash accounting. If you’re using traditional accounting (see above), you’ll also need to keep records of:

  • What you’re owed but have not received yet
  • What you’ve committed to spend but have not paid out yet, e.g. you’ve received an invoice but have not paid it yet
  • The value of stock and work in progress at the end of your accounting period
  • Your year-end bank balances
  • How much you’ve invested in the business in the year
  • How much money you’ve taken out for your own use (i.e. your drawings)

There are no rules on how you must keep records. You can keep them on paper or digitally, however HMRC expects Sole Traders to keep at the least the last 6 years of business records.

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