What is the cash basis of accounting?

Definition of the cash basis of accounting

The cash basis of accounting allows certain businesses to work out their profit based on when money comes in and is paid out, rather than on when income is earned and costs incurred.

Cash basis accounting is not available to all businesses, only to:

  • sole traders
  • partnerships whose partners are all individuals

Limited companies and LLPs may not use the cash basis of accounting.

There are also certain costs that aren’t allowable for tax relief when you’re using the cash basis, such as bank interest over a limit of £500. You can learn more about it from HMRC.

Example of the cash basis of accounting:

The Peter and Paul Partnership prepares accounts each year to 5th April. They do some work in March which they invoice for on 31st March. Their customer pays them on 10th April.

If they are not using cash basis accounting, they record that income in the accounts for the tax year that ended 5th April (the tax year in which the invoice was issued).

If they are using cash basis accounting, they record that income in the accounts for the tax year ending on 5th April the following year (the tax year in which the invoice was paid).

Disclaimer: The content included in this glossary is based on our understanding of tax law at the time of publication. It may be subject to change and may not be applicable to your circumstances, so should not be relied upon. You are responsible for complying with tax law and should seek independent advice if you require further information about the content included in this glossary. If you don't have an accountant, take a look at our directory to find a FreeAgent Practice Partner based in your local area.

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