Cash Basis vs Traditional Accounting 17

If you are planning on starting a new business or becoming self-employed, it’s worth spending some time deciding on which method of accounting you are going to use to manage your business’s finances. 

There are two main types of accounting, Traditional Accounting and Cash Basis Accounting.  

Read on for more information on everything you need to know about these different accounting methods and which one will suit your business best… 

Traditional Accounting 

What does traditional accounting involve? 

Most large businesses use traditional accounting – also sometimes known as accrual basis accounting. With traditional accounting you record your income and expenses by the invoice date, regardless of whether you have been paid or not. 

As an example, if you sent your customer an invoice on 30th March 2021, you would record that invoice under the 2019 – 2020 tax year, even if the invoice wasn’t paid until 30th April 2021 which would be in the following tax year. 

With this method you will pay Income Tax whether you have received the money or not. 

When using the traditional accounting method, you are required to keep all records of income and expenditure including: 

  • All sales income 
  • All purchases and expenses. 
  • Any stock/equipment purchased for the business 
  • The value of stock and work in progress at the end of your accounting period 
  • Details of payments to employees such as wages, bonuses, expenses, benefits, etc 
  • Business vehicle and travel costs 
  • Interest on bank or building society accounts 
  • Any other income received including money invested in your business 

What kind of businesses is traditional accounting suited for? 

Traditional accounting is usually more suited to larger businesses, or those predicting that their business will grow quickly. 

Cash basis accounting 

What does cash basis accounting involve? 

The cash basis accounting method records money when it is actually received or paid out of your business and is the simplest way to manage your accounts. 

As an example, if you invoiced a customer on 30th March 2021 but did not receive payment until 30th April 2021 you would record this income for the 2021 – 2022 tax year. 

With cash basis accounting you will only have to pay Income Tax on money that you actually received within your accounting period.  

Unlike traditional accounting, with cash basis accounting you can: 

  • Include payments for equipment as allowable expenses 
  • Claim up to £500 as an allowable expense for interest paid on cash borrowings 

What kind of businesses is traditional accounting suited for? 

The cash basis accounting method is much better suited to small business and the self-employed with an income of £150,000 or less. 

How to change from cash basis to traditional accounting 

If you start off using cash basis accounting and your business grows, you have two options:  

Option 1 – continue using cash basis method until the year after your turnover is higher than the exit threshold of £300,000. 

Option 2 – switch from cash basis to traditional accounting 

If you have any questions on traditional accounting or cash basis accounting, or are looking to switch from cash basis to traditional accounting, feel free to get in touch with us here at Magpie Accountancy.