Our guide to the Cash Basis of preparing Accounts and UK Tax Returns.
The Cash Basis is a relatively new basis of calculating profits and Income Tax for small Self Employed businesses in the UK, for filing Self Assessment Tax Returns, and is optional. It was introduced by HMRC in 2013.
Introduction to the Cash Basis
The advantages of the Cash Basis is that records are kept, and profits and tax are calculated, based on the day that payments are made (ie. when the money moved), not the date on the fee invoices and bills.
Using the date that fees are received, and bills are paid, might seem the most obvious, and it’s usually the easiest method, but it is not the historically accepted method.
You can opt for the Cash Basis if your fees are below £150,000 (from April 2017).
The main basis for calculating profit and tax is still the ‘accruals’ basis.
Why are there different ways of calculating profit and tax?
For example: If your are completing your 2019/20 Self Assessment, and your accounts are up to 5/4/20: If you had a bill dated in March 2020, which you paid in May 2020, this expense would not be allowed as a tax deduction for 2019/20 if you selected the Cash Basis option. The tax deduction would be allowed for 2020/21, the tax year in which the bill was actually paid.
On the other hand, for your fees, if your fee invoice is dated March 2020, and you did not get paid until May 2020, if you chose the Cash Basis, you would declare the fee on your 2020/21 tax return.
The Accruals Basis is the historically required basis, and is still the legally required basis for limited companies.
The Accruals Basis records fee income and expenses on the date of the treatment or expense, ie. the invoice date, not the date they are paid.
In healthcare, the treatment and the payment are often on the same day, so in reality there is usually very little difference.
Comparing the Cash and Accruals Bases
So which makes more sense? You may conclude that with ‘swings and roundabouts’ and lots of sales, the cash basis would even itself out. It might, but it might not. Certainly the Cash Basis will probably be easier for most small businesses.
The Accruals Basis is used for larger businesses because it more accurately matches the sale with the cost of the sale in the same accounting period, which makes financial reporting more meaningful. Of course, this requires more accounting expertise to get it right. The accruals basis is also a legal requirement for larger business. limited companies must use the accruals basis by law.
HMRC have accepted that for small businesses, the extra accounting cost of the Accruals Basis might be an extra burden. Therefore the Cash Basis option has been introduced, because the accounts are easier to prepare.
If you choose this option, you will simply record your sales and purchases on the day you received or paid the cash. You might be doing this anyway.
We use the Cash Basis for our Self Employed healthcare clients, unless they prefer the accruals basis because of their business circumstances.
This was just an outline, there are some rules to be aware of which we will explain to our clients if the need arises.