For the many sole traders and partnerships, managing finances and preparing for the year-end tax return can be a significant administrative burden. Traditionally, this has involved accrual accounting – a method that requires you to account for all invoices and bills when they are issued, not when they are paid.
However, in a major move to simplify tax for the sole trader or self-employed, HMRC has introduced significant changes that make a much simpler method – cash basis accounting – the new default.
Here at The Accountancy Office, we want to break down what this change means for you and your business. It’s a positive development that could make your bookkeeping easier and improve your cash flow, but it’s important to understand if it’s the right fit.
What is Cash Basis Accounting?
In simple terms, the cash basis is a method of accounting that records income and expenses only when money actually changes hands.
- Income is recorded when it lands in your bank account.
- Expenses are recorded when you actually pay for them.
This straightforward approach eliminates the need to track debtors (money you’re owed) and creditors (money you owe) for your tax return, offering a much clearer, real-time picture of the cash available to your business.
What Has Changed for the 2024/25 Tax Year?
Previously, the cash basis was an optional scheme with strict turnover limits. From April 2024, HMRC has supercharged the scheme, making it more accessible and beneficial than ever before. The key changes are:
- It’s Now the Default: Cash basis is the new standard for sole traders and partnerships. If you want to use the traditional accrual method, you now have to actively choose to do so on your tax return.
- Turnover Thresholds Scrapped: The previous entry limit of £150,000 and exit limit of £300,000 have been completely removed. This means unincorporated businesses of any size can now benefit from this simpler system.
- Finance Cost Cap Removed: The previous cap that limited the deduction of interest and financing costs to just £500 has been abolished. You can now deduct the full interest costs, provided they are incurred wholly and exclusively for the business.
- More Flexible Loss Relief: Restrictions on how you can use a business loss have been lifted. Under the new rules, losses calculated on the cash basis can be used in the same way as accrual losses, meaning they can be offset against your other income from the same or previous year.
The Benefits of Using the Cash Basis
For many businesses, these changes make the cash basis an attractive option:
- Simplicity: Your record-keeping is significantly simplified, making it easier to manage your own books.
- Improved Cash Flow: You only pay tax on money you have actually received. This can be a huge advantage if your clients are often slow to pay.
- Clear Financial Picture: It provides an immediate and easy-to-understand snapshot of the cash your business has at any given moment.
Is the Cash Basis Right for Everyone?
While the cash basis is a fantastic simplification for many, it’s not a one-size-fits-all solution. For example:
- Businesses that hold large amounts of stock may find the accrual basis gives a more accurate reflection of their profitability.
- If you are seeking significant business finance, lenders often prefer to see accounts prepared on an accruals basis as it shows a complete picture of your financial health, including future liabilities and income.
- The cash basis is not available for Limited Companies.
The new, expanded cash basis is a great opportunity for many sole traders, but it’s crucial to get it right.
To find out more and discuss what these changes mean for you, get in touch with our team today.