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).