From 6th April 2013, small businesses can choose to do their accounting on a cash basis. This is part of a drive to simplify how the income tax system applies to small firms.
A business with sales receipts below the VAT threshold (currently £79,000) can use the scheme and this level is doubled where the business owner is a recipient of Universal Credit.
The changes do NOT apply to companies. If you run your small business through a company then the Companies Act still applies and your company’s accounts need to be prepared on the same basis as always. There are also some businesses that will not qualify for cash accounting so it’s worth talking to your accountant.
What does cash basis accounting mean?
Simply, your income is the amount of cash you receive from customers (ignoring what you are owed by debtors) and your expenses are what you have spent (ignoring what you owe to creditors). The profit is the difference between the two.
Tax will be payable only on income that is received, and relief for expenses will be available only when they have been paid.
The idea is that using the cash basis is simple and more understandable than the traditional “accruals” basis, where you recognise sales and purchases as soon as you make them, not later when payment is made.
The cash basis also makes record-keeping easier – although you still need to keep all of the invoices and receipts in case HMRC wants to see them, a business bank account that is only used for business transactions will be the main financial record from which your accounting can be done. Make sure you pay for all business expenditure using a debit card or online payment and your bank statement should tell the whole financial story for you.
Is cash basis accounting that simple?
In theory, yes. And for the majority of transactions for most businesses, it will be simpler. However, there are a couple of potential complications to be aware of.
Firstly, the transitional rules when a business goes into the scheme or comes out of it need to be followed. The principle is that an item of income or expenditure comes into the profit calculation only once. This will require careful record-keeping.
Secondly, there are special rules for claiming motoring expenses and the use of your home for business purposes. Again, there are rules to understand and records to keep.
These complications are probably fairly small issues for most businesses that are considering using cash accounting, but it would be sensible to talk to your accountant before making the switch.
Can QuickBooks help?
Yes – you can change the basis of many reports in QuickBooks from the “accruals basis” to the “cash basis” in the Reports preference.
And you can look at earlier years’ and this year’s results and switch the basis of the reports to see how much the difference in profit would be if you changed.
Don’t forget to save the tax you owe
As the year unwinds and you make money, your bank balance will increase but do not forget that some of this increase in cash will be payable to HMRC in income tax – so be very careful not to spend it all!