Cash basis or traditional accounting: which suits your business?

The short answer

The cash basis counts money when it actually moves. Traditional accounting counts income and costs when you invoice or are billed, whether or not anyone has paid yet.

Since 6 April 2024, the cash basis has been the standard method for sole traders and for partnerships with no corporate partners. You use it unless you choose traditional accounting instead, or unless your business is not allowed to use it.

Neither method changes how much profit your business makes over its lifetime. What changes is the tax year a sale or a cost falls into, plus a few specific rules about equipment and certain trades.

How the cash basis works

Under the cash basis you record income only when you receive it. If a customer has not paid by the end of the tax year, that money is not income for that year. It counts in the year it reaches you.

Costs work the same way. You only count an expense once you have paid it. A bill sitting on your desk unpaid at the year end does not reduce that year's profit.

HMRC asks you to choose one point at which to record income, for example the date money lands in your bank account, and to use it every year. Cash, card, cheque and payment in kind all count as receipts.

Equipment under the cash basis

One of the biggest practical differences is equipment. On the cash basis, most equipment, such as tools, computers and vans, is claimed as a normal allowable expense when you pay for it. You do not need to work out capital allowances for it.

Cars are the exception. You can claim capital allowances on a car, but only if you are not using simplified expenses (the flat mileage rates) for that vehicle.

How traditional accounting works

Traditional accounting is sometimes called accruals accounting. You record income on the date you invoice, and costs on the date you are billed. Payment timing does not matter.

So if you send an invoice in March and the customer pays in May, the sale belongs to the tax year that includes March. The same goes for a supplier bill dated before the year end but paid after it.

This gives a truer picture of what the business earned and spent in a period. The trade-off is more record keeping. You need to track what customers owe you, what you owe suppliers, and usually the value of any stock you hold at the year end. Equipment is normally dealt with through capital allowances rather than as a simple expense.

When you file your Self Assessment return, you need to say that you used traditional accounting.

Side by side

• When income counts. Cash basis: when you are paid. Traditional: when you invoice.
• When costs count. Cash basis: when you pay. Traditional: when you are billed.
• Unpaid invoices at year end. Cash basis: not taxed yet. Traditional: taxed in the year you invoiced.
• Equipment. Cash basis: usually a straight expense, cars aside. Traditional: usually capital allowances.
• Records. Cash basis: lighter. Traditional: you also track debtors, creditors and stock.
• On your tax return. Cash basis is the default. Traditional needs to be stated.

Who can use the cash basis

The cash basis is open to sole traders and partnerships with no corporate partners. If you run more than one business, you can choose a method separately for each one.

Some businesses cannot use it. GOV.UK lists these:

• Limited companies, limited liability partnerships and partnerships with a corporate partner
• Lloyd's underwriters
• Farming businesses with a current herd basis election
• Farming or creative businesses with a fluctuating profit averaging claim
• Businesses that claimed business premises renovation allowance in the previous 7 years
• Businesses carrying on a mineral extraction trade
• Businesses that have ever claimed research and development allowance

If you are in one of these groups, you must use traditional accounting.

GOV.UK also lists some trades that may prefer traditional accounting because certain profit rules only apply under it. These include dealing in securities, claiming relief for lease premiums or mineral royalties, and ministers of religion, among others.

What changed in April 2024

Before the 2024/25 tax year, the cash basis was something you had to choose, and it had limits. Turnover had to be £150,000 or less to join, and you could only stay in up to a turnover of £300,000.

From 6 April 2024 the government made three main changes for trading businesses:

• Default method. The cash basis became the default, with an election to opt out into traditional accounting.
• No turnover limit. The £150,000 entry and £300,000 exit limits were removed.
• Interest and losses. The old £500 cap on deducting interest was removed. Losses made on the cash basis can now be used in the same way as losses under traditional accounting.

So many of the old reasons to avoid the cash basis no longer apply. A larger business, or one that borrows to fund its trade, can now use it without losing out on those points.

A worked example

Which should you choose?

The cash basis usually suits you if

• Most customers pay straight away, or within a few weeks
• You hold little or no stock
• You want your tax bill to follow the money you actually have
• You buy equipment and want to claim it as a straight expense

Traditional accounting may suit you if

• You give long payment terms, so invoices often run across the year end
• You hold a lot of stock or work in progress
• You want figures that match what a lender or buyer will expect to see
• Your business is excluded from the cash basis, or a trade-specific rule only works under traditional accounting
• You plan to turn the business into a limited company, which cannot use the cash basis

Whichever you choose, use it consistently. Switching from one method to the other can need adjustments so that income or costs are not counted twice or missed. If you have been claiming capital allowances, GOV.UK points to HMRC helpsheet HS222 for the changes needed. Take advice before you switch.

VAT, Making Tax Digital and the cash basis

The cash basis for income tax is separate from the VAT cash accounting scheme. Using one does not put you on the other.

On the cash basis you can record figures with or without VAT, but you must treat income and expenses the same way. If you include VAT, the VAT you pay to HMRC counts as an expense and any VAT repayment counts as income.

Making Tax Digital for Income Tax now applies to sole traders and landlords with qualifying income over £50,000, from 6 April 2026. It extends to those over £30,000 from 6 April 2027, and to those over £20,000 from April 2028. Qualifying income is gross income from self-employment and property before expenses. If you are in it, you keep digital records and send short quarterly summaries through compatible software. Either accounting method still needs clean, up-to-date records behind it.

Records you need either way

You do not send your records to HMRC with your return, but you must keep them in case HMRC checks. On the cash basis, that means a clear record of money in and out, with receipts and invoices to back each item up. On traditional accounting, you also need invoice and bill dates, a list of who owes you and who you owe at the year end, and stock values.

Both methods get much easier when the bank feed is reconciled regularly and each payment is matched to its paperwork as it happens, rather than in a rush before the deadline.