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Cash Basis Accounting

From April 2026 Cash Basis Accounting for Income Tax is standard for Unincorporated Businesses, with an opt out back to Accruals Accounting.

Cash Basis is known to many businesses from VAT, but its application to Income Tax differs.

In this brief we talk about Cash Accounting for VAT, Cash Basis Accounting for Income Tax and Simplified Accounting for Income Tax.

 

Cash v Accruals Accounting – VAT

Cash accounting means transactions are reported for VAT according to the date they are paid or received.

Accruals accounting, also known as Invoice Accounting, for VAT means transactions are reported by reference to the date of the invoice.  This is the default for VAT accounting.

For most businesses Cash Accounting is the simplest and most logical option, and if you sell on credit, with customers owing you money, it will help your cash flow.  However Invoice Accounting may benefit you if you buy a lot of goods on credit and pay suppliers sometime later – you will recoverer VAT Input Tax earlier.

You are eligible to join cash accounting for VAT if your turnover is less than £1.35m.

If you use the Flat Rate Scheme then you will automatically be using a form Cash Accounting.

HMRC Guidance on Cash Accounting

 

Cash Basis v Accruals Basis Accounting – Income Tax

Cash Basis Accounting means transactions are reported for tax according to the date they are paid or received.

Accruals Basis Accounting for Income Tax  means transactions are matched to the period they relate to, eg:

  • Income is reported when earned rather than received
  • Expenses are reported against the period the income is earned in, rather than when paid

From April 2024 Cash Basis becomes the default for Unincorporated Businesses (Sole Traders and Partnerships) although they will be able to elect into Accruals Accounting.

Circumstances when you may wish to elect into Accruals Basis:

  • You’ve received monies in advance and will incur costs in a later tax year – Accruals Basis will match the income to the expense in the same tax year.
  • You hold a lot of stock or work in progress – Accruals Basis will ensure that the value of this is carried forward and profits aren’t depressed in the year of acquiring the stock or WIP.
  • You sell goods on credit to customers and wish to match the revenue to the costs of acquiring, manufacturing and processing the goods.
  • You need to show a certain level of profit for lending or mortgage purposes, and the absence of debtors, stock or work in progress will hinder this.

Lets look at an example:

Pat’s business year end is 5 April annually in line with tax year.  He is engaged on a commissioned project, with cash flow as follows:

      • He receives a deposit from the the customer of £1,000 in March 2025
      • He receives the balance from the customer of £4,000 in May 2026
      • He pays a sub contractor for design work £2,000 in June 2025
      • He buys materials of £1,000 in April 2026

Under Accruals Basis Accounting this is all reported in 2026/27 – Income of £5,000 and expense of £3,000

Under Cash Basis Accounting, he reports:

      • 2024/25 Income £1,000
      • 2025/26 Expense £2,000
      • 2026/27 Income £4,000 Expense £1,000

Cash Basis Accounting means some income is taxed earlier, and some expenses are relieved earlier.  Income and expenses are split over three years.

A few points to note:

  • For most small businesses, which tend to be quite simple and not buy or sell on credit, Cash Basis Accounting tends to happen automatically.
  • For businesses who take or make deposits, hold stock or work in progress, or buy or sell on credit, Accruals Basis Accounting tends to be preferred as it makes sure transactions are matched.
  • You do not have to use the same accounting basis for VAT and Income Tax.

HMRC guidance on Cash Basis

 

Corporation Tax

Companies are not allowed to use cash accounting, and must account on an accruals basis.

 

Simplified Accounting

Simplified Accounting is an HMRC scheme to simplify some expenses for small businesses under Self Assessment for Income Tax.

It covers:

HMRCs guidance is here, and our guidance on Car Costs and Working From Home / Home As Office Expenses reflect the Simplified Accounting guidance.

Our advice is to use the simplifications where appropriate.