From the 2024/25 tax year, cash basis accounting will become the default method for most sole traders and partnerships completing their Self-Assessment tax return. But is this new approach right for you, or would sticking with accrual accounting give you better control over your finances?
In this blog, we break down the key differences between cash and accrual basis accounting, highlight the benefits and drawbacks of each, and help you decide what’s best for your business.
What Is Cash Basis Accounting?
Cash basis accounting is a simplified method of recording income and expenses. You only report income when it’s actually received, and expenses when they’re paid.
Example: You invoice a client in December but get paid in January. Under cash basis, that income is recorded in January, the date the money hits your account.
This differs from accrual accounting, where income and expenses are recorded when earned or incurred, regardless of when the money is received or paid. Under accruals, that December invoice would still be recorded in December, even if the cash hasn’t arrived yet.
Why Is HMRC Making Cash Basis the Default?
HMRC is switching to cash basis by default to reduce administrative burdens for small businesses. If you’re a sole trader or unincorporated partnership, you’ll automatically be enrolled in the cash basis from 2024/25 unless you choose to use accrual accounting on your tax return.
What Are the Benefits of Cash Basis Accounting?
1. Easier Bookkeeping for Small Businesses
Cash basis accounting is more straightforward, with fewer accounting entries to manage. You don’t need to calculate outstanding invoices or prepayments, which can make day-to-day record keeping easier.
2. Improved Cash Flow Management
Since you’re only taxed on income you’ve received, your tax liability is better aligned with your actual cash flow. If a customer hasn’t paid yet, you won’t be taxed on that income.
3. Reduced Reporting Requirements
No need to report on accruals, deferred income, or prepayments, making your accounts simpler and potentially lowering accountancy fees.
4. Lower Tax Bills in Certain Situations
If you have delays in getting paid or hold large stock amounts, using cash basis could reduce your short-term tax liability.
Potential Drawbacks of Cash Basis Accounting
While the simplicity is attractive, cash basis accounting isn’t for everyone.
Not Available to All Business Types
- Limited companies and LLPs can’t use cash basis
- Certain farming and creative businesses using specific tax reliefs (e.g. profit averaging or herd basis) aren’t eligible.
Delayed Tax Relief on Purchases
If you buy assets or stock on credit, you won’t be able to claim tax relief until payment is made. This could significantly delay relief on big purchases.
Limited Insight into Business Performance
Cash basis doesn’t show what you’re owed—or what you owe. If you have many outstanding invoices or supplier payments, this can make cash flow and business performance harder to manage.
Not Ideal for Financing or Investment
Lenders and investors often require full financial accounts prepared using the accruals method. You might end up needing to prepare both cash and accrual-based sets of accounts, doubling the work.
Switching Between Methods Can Be Complicated
Changing between cash basis and accrual accounting involves transitional adjustments that could impact your tax position, especially in the first year.
How to Decide: Cash Basis vs Accrual Accounting
Ask yourself:
- Am I eligible for cash basis accounting?
Some businesses are excluded by HMRC rules. - Will cash basis simplify or complicate my records?
Review whether your current accounting system would need to change. - How will this affect my tax planning and cash flow?
Consider the impact of transitional adjustments. - Do I need accrual-based figures for banks or investors?
If so, it may be better to stick with the accruals method.
Thinking of Switching? Talk to Us First.
At SBCA, we help small business owners like you make confident financial decisions. Whether you’re a sole trader or running a growing partnership, we’ll review your situation and advise on the best accounting method for your goals.
Chat through the pros and cons of using cash basis accounting versus the traditional accruals basis with us and we’ll help you avoid any surprises and stay in control of your finances.
Email prosper@sbca.co.uk or call 01772 204102
Read what HMRC have to say here: Cash basis: Overview – GOV.UK
Have you seen our blog on MTD for Income Tax? Read more here: Making Tax Digital for Income Tax – What You Need to Know – SBCA Chartered Accountants