In most cases, self-employed individuals and small businesses will benefit from using cash basis and simplified expenses accounting practices.
The main reason is that you only record income and expenses as cash flows in and out of the business (e.g. not the actual date when it is invoiced or received).
Your business may qualify to use cash basis accounting procedures - a way of working out income and expenses for Self Assessment tax returns.
In most cases, cash basis and accrual basis are simplified methods used for business accounting and record keeping.
Note: Running a small business on the cash basis accounting system may suit you better. If not, you must use the traditional accrual basis of accounting instead.
The cash basis method is much simpler for working out business taxes and finances. You only declare money when it actually comes into, and goes out of, the operation.
Why is this important?
This is a big advantage for small businesses - especially at the end of the financial tax year. You do not need to pay Income Tax on revenue unless you receive it in your particular accounting period.
There are situations where cash basis accounting procedures will not suit a business. As a rule, the process is unlikely to benefit an organisation if it:
Note: Always discuss your situation with a tax professional if you need help. Contact an accountant or a legal adviser for expert advice about business accounting.
Your small business can only use cash basis accounting procedures if:
What if you are running more than one business on the cash basis scheme? In this case, you must run them all on the same program. But, note that the combined turnover of all the businesses must not go over £150,000.
If the business expands you can continue using the scheme. But, only while the total business turnover stays at £300,000 (or less) per year. If it goes above £300,000 you must start using traditional accounting in the next tax return.
Cash basis accounting rules do not accept limited companies or limited liability partnerships. Some specific types of business operations do not qualify for the scheme either, such as:
Note: Use traditional accrual accounting if you are ineligible for cash basis. Read 'How to calculate your taxable profits: HS222 Self Assessment helpsheet' for advice.
Make the calculations at the end of the tax year. You should work out the taxable profit from cash basis income and expenses records. Select the 'cash basis box' on the form when you send in your tax return.
Note: You can only use cash basis accounting for the 2013 to 2014 tax year onward. What if you send a late tax return for tax years before 2013? You must use traditional accounting to calculate your accounts for any previous years.
You can switch from traditional accounting to cash basis. But, you may need to make some adjustments when you make the change. You can get further information on the HS222 helpsheet or from a tax professional.
You have responsibilities for keeping business records and paperwork if you are self-employed. You need records of income and expenses to work out profit margins for the tax return.
Cash basis reporting means you only record the income you actually received in the tax year. You do not need to record any 'owed money' until you receive it.
You wrote an invoice on the 19th of March 2021 for a customer. But, the business did not receive the money until the 19th of April 2021.
Thus, you would record this income in the 2021 to 2022 financial tax year.
Cash basis accounting rules allow you some choice on recording the money. You can record it on the date the money enters your account or on the date that a cheque gets written. But, whichever one you choose it must be the same method used for each tax year.
Important: All forms of payment types count (e.g. cash, card, cheque, payment in kind, or any other method).
You can deduct business expenses as costs from income to work out the taxable profit. Doing so means your allowable expenses reduce the amount of Income Tax you pay.
But, you can only count the business expenses that you actually paid for. Any money that the business owes out does not count until it gets paid as an expense.
Examples taken from a list of allowable business expenses for self-employed workers using cash basis include:
You can use the simplified expenses scheme from 2013/14 tax year onward to calculate:
Special rules will apply if you buy a car for the business. In most cases, you will claim it as capital allowances on business cars. But, this only applies if you are not using simplified expenses to work out expenses for that car or vehicle.
Cash basis accounting is different from traditional accounting. You claim other equipment kept and used in a business as a normal allowable business expense. Thus, you do not claim it as a standard capital allowance.
Note: You can switch from claiming capital allowances to cash basis. But, you may need to make adjustments when you make the change. Read further information on the HS222 helpsheet or contact a tax professional.
You only need to send in a tax return to HM Revenue and Customs - not the business records. But, you do need to keep the paperwork for at least six years in case HMRC ask to inspect them in a tax compliance check.
You can start using cash basis accounting even if your business is VAT registered. But, the income must be not more than £150,000 for the tax year.
How does that work?
Simply put, you can choose to record the business income and expenses including or excluding VAT. However, whichever one you choose, you must treat all income and all expenses in the same way.
Businesses that choose to include Value Added Tax in their cash basis accounting must also record:
Note: The short video presented by HM Revenue and Customs (HMRC) will help you determine whether cash basis accounting will make life easier as a self employed business.
Cash Basis and Simplified Expenses for Self-employed in United Kingdom