The cash basis of accounting
2024/25 brought a shift in how profits are calculated for sole traders and partnerships.
In the majority of cases, profits have historically been calculated on the accruals basis. This means income and expenses are recorded when the activity takes place or on the invoice date, regardless of when the money was received or paid.
The cash basis instead records income and expenses based only when the money is received or paid. Invoices and receipts don’t get included in your figures until they are paid.
From 6th April 2024, the restrictions on who could use the case basis were removed, and it became the default basis for accounting, opening it up to a wider range of traders. So with the end of the tax year approaching, 2024/25 is the first year cash basis because the default basis.
When the cash basis might suit your business
Under the cash basis, tax is only paid when money is actually received.  Sounds great yes?   Well in some cases it is. It’s simpler for the smallest traders, and businesses with longer payment terms will have a cashflow benefit, as the cash basis will defer the tax on unpaid invoices into the next year.
When the cash basis might not suit your business
The problem is the cash basis doesn’t give you a true picture of what is going on in your business. Monitoring performance will be difficult as any unpaid bills aren’t included in the figures, so it could show a profit just because bills haven’t been paid. And if you need to apply for finance, lenders are likely to want to see accruals accounts.
Also, whilst those with high levels of unpaid customer invoices will gain a tax cashflow advantage, those with higher unpaid supplier invoices could be at a cashflow disadvantage, as the supplier costs are claimed earlier under accruals accounting.
Who cannot use the cash basis
The cash basis is not open to Limited Companies, and some specific types of business cannot use it, including those claiming R&D relief, managed service companies and some farmers. There is a full list of excluded businesses available at HMRC.
Our opinion
We believe traditional accruals accounting will be more beneficial for the majority of our clients. We want them, and us, to have the right information available in order to effectively manage their business and make the right decisions. We also recognise that there will be an advantage to using the cash basis for some businesses. We will review this on a case by case basis and make the best assessment for our clients circumstances.
If you would like to discuss what this means for your business, please contact us.