Wondering what is cash basis accounting? It is an accounting method that you need to know as a small business owner in the UK, as it is well suited for non-complicated business setups. It is a simple way to manage your finances than traditional accounting. If you’re a sole trader or a partnership business, cash basis accounting can be an effective way to manage your finances. Let’s see: what is cash basis accounting, who needs to use it, why use this accounting method and what is traditional accounting!
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What is Cash Basis Accounting?
It is an accounting method used by businesses to calculate their profit based on the money that actually comes in and goes out of your business on a specific date or on which expenses were paid out. It is a simplified accounting method suited for small businesses.
Here, the income and expenses are recorded into the accounts only when the money is received and paid out. So it means when a business acquires equipment or land and paid out, it will then be included as an expense. On the other hand, when a business performs a credit transaction, this will only be included if the money is actually paid or received.
A business owner should select cash basis accounting on the Self-Assessment Section of the Tax Return. Let’s see whether you need to choose this accounting method.
Who Needs to Use Cash Base Accounting?
As a general rule of thumb, you need to use cash base accounting if:
- You’re self-employed, a partnership or a sole trader with an annual turnover below £150,000
However, if you earned more in a year, you can use this method up to a turnover of £300,000 a year. If it goes above this, you need to consider traditional accounting (for your next tax return). Know that limited companies and limited liability partnerships (LLPs) are not eligible to use cash base accounting. And there are some other businesses too that can’t use this method.
Why Use Cash Basis Accounting?
Cash basis accounting is suitable for some small businesses. Those businesses that do not perform transactions on credit can use this method to evaluate their financial performance.
You need to use cash basis accounting if:
- You’re sole proprietorship or partnership
- You use simple single-entry accounting (instead of double-entry accounting)
- The business does not deliver goods and services on a credit
- There are few financial transactions each day
- Your business has only a few employees
- At the time of sale, the customer pays by cash, credit/debit card, cheque or wire transfer
- The business has no inventory to be recorded or valued
Understanding Traditional Accounting
It is also called accrual basis accounting. Here, every single transaction is recorded, when an invoice is sent or received, no matter it is paid or not. This accounting practised is best suited for those who:
- Invoice customers
- High stock levels
- More staff
- Invoiced by suppliers
- Need to use Sideways Loss Relief
- Has turnover over £150K in a year
- Are complex business models like Limited companies or LLPs
Quick Sum Up
To sum up the discussion of what is cash basis accounting, you have now come to know that it is ideal for simpler, and smaller businesses that don’t receive or pay a large sum of money. You can register it in your Self-Assessment Tax Return. So, this is a preferable method for sole traders, self-employed, partnerships and small businesses with a turnover below £150K in a year. On the flip side, large businesses, limited companies and LLPs should choose the traditional accounting method to manage their finances effectively.
You can get in touch with our accountants to help you with both accounting methods. Talk to one of our chartered accountants in Croydon about the online accountancy services we provide. We are just a click away! We provide accounting, payroll, and taxation services in affordable packages!
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Disclaimer: This blog contains general information about Cash Basis Accounting.