Cash based accounting for self employed explained
When you fill in your self assessment tax return, there is a box to tick that asks you if you are using cash-based accounting. What does this mean?
What is cash-based accounting
Cash-based accounting, as opposed to accrual-based accounting, is a system that only recognises revenue and expenses as and when the cash is paid or received. This system best suits individuals or small businesses that mainly transact in cash and don’t need to publish financial statements. This accounting method makes it very simple for these businesses to account for their profit and loss.
With the cash-based accounting, there are no creditors or debtors, and consequently, no accounts payable or receivable recorded unlike under the accrual system.
If your business has inventory, then the cash-based accounting is not suitable.
The accrual accounting method records sales and expenses as they occur, regardless of when the funds were paid or received. This is the method that is recognised by International Financial Reporting Standards (IFRS) and is acceptable under Generally Acceptable Accounting Principles (GAAP).
The accrual accounting method produces a more accurate snapshot of the profitability of a company.
In the UK, this was introduced in the 2013-2014 tax year and was for anyone who earned less than £81,000 that tax year. You can carry on using cash-based accounting until your income reached £162,000. Over that amount, you will have to use regular accounting practices.
This is a good option if your self employed business is quite simple and easy to track and you don’t have any other income. Cash-based accounting will not be a good option if you have any of these:
Interest income over £500 a year
If you are VAT registered, these cash basis accounting records are not going to have enough details for VAT reporting.
If you have other income and if your self employed business is loss-making, you won’t be able to offset the losses. This will result in you having to paying tax on the profitable income.
