What is Cash Accounting?
Cash accounting, also called cash-basis, is a method of recording income and expenses based on when money actually enters or leaves your business account. This means you record a payment only when you receive it, and an expense only when you pay it.
Who Can Use Cash Accounting
In the UK, cash basis accounting is generally available to small self-employed businesses, such as sole traders or partnerships, with an annual turnover of £150,000 or less. If you run multiple businesses, the combined turnover must remain below this threshold to qualify.
If your business grows during the year, you can continue using this method until your turnover reaches £300,000. However, once it exceeds this limit, you’ll need to switch to accrual accounting for your next tax return.
Limited companies and certain types of businesses, such as waste disposal or securities dealers, cannot use cash accounting.
Benefits
The appeal of cash accounting lies in its simplicity. You only record transactions when money changes hands, eliminating the need to track invoices, unpaid bills or long-term liabilities. This method is especially helpful for businesses that want a clear understanding of their immediate cash flow.
It also reduces administrative burdens by focusing on what’s happening in the moment, rather than anticipating future payments or expenses.
Limitations
While cash accounting is simple, it may not give a complete picture of your financial health. Since it only tracks actual payments, it can sometimes create a misleading impression of how much cash you truly have.
Another drawback involves tax implications. Since you can only deduct expenses when you pay them, late payments or delayed purchases could push deductions into the next tax year. This could affect your taxable profit and, potentially, your cash flow management.
Finally, switching from cash to accrual can be challenging as your business grows. You’ll need to reconcile the timing differences between when you recorded transactions and when you exchanged goods or services, which can take time.
The VAT Cash Accounting Scheme
If you register your business for VAT, you might also qualify for the VAT Cash Accounting Scheme. This scheme allows businesses to account for VAT based on when they receive payments, rather than when they issue invoices.
However, this scheme may not be beneficial for businesses that regularly reclaim more VAT than they pay or make continuous supplies of services.
To be eligible for the scheme, your taxable turnover must be £1.35 million or less in the next 12 months. Additionally, you must not owe any unpaid VAT to HMRC or have a VAT offence conviction in the last year.
Cash Accounting vs. Accrual Accounting
Cash accounting differs from accrual accounting, where you record transactions when they occur, regardless of when you receive or pay money. With cash accounting, you work with real, tangible funds, while accrual accounting focuses on the timing of earning revenue and incurring expenses, even if you haven’t yet made or received payments.
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