There are two accounting methods used by small businesses – cash basis accounting and accrual basis accounting. Cash basis is often favoured by sole traders and partnerships, as it involves recording revenue and expenses when payments are received and made, while accrual basis requires recording transactions as they occur rather than when invoices are paid.
Small businesses using the cash basis method don’t have to wrangle with accruals or most capital allowances, but there is a turnover limit that forces businesses to switch from cash basis to accrual basis at a certain point. The government wants to make this simpler to help new businesses meet their tax obligations as they grow.
With HMRC looking into cash basis reform, here’s how the cash basis scheme could change, and how it could affect your small business.
What is the cash basis income threshold?
Currently, small self-employed businesses can only use the cash basis scheme if their turnover is below £150,000 a year (though they don’t need to leave the scheme until their annual turnover reaches £300,000). This threshold applies to all businesses owned – meaning if you have more than one, their combined turnover must not exceed the threshold.
As announced in the 2023 Spring Budget, the government will be consulting on ways to expand the cash basis scheme to expand eligibility and make the tax system easier to understand. Some of the ways that HMRC is considering increasing its availability include:
- Setting the turnover limit at £1.35 million
a year, with businesses not having to leave the scheme until their annual turnover reaches £1.6 million. - Removing the turnover threshold entirely so that any business can use the cash basis scheme, regardless of its size.
The first suggestion, if implemented, would set the same limits as the VAT cash accounting scheme.
While cash basis is currently an ‘opt in’ system, HMRC is also considering a change to an ‘opt out’ system, meaning it would become the default for eligible businesses.
Will loss relief rules change?
Some businesses may not want to opt in to using cash basis accounting due to restrictions on interest cost reliefs and losses. Currently, interest and bank charges have a maximum deduction of £500, and traders can only carry losses forward – they can’t be carried backward, or relieved against other income.
Though HMRC hasn’t announced anything definitively, the maximum interest and bank charges deduction could be increased up to £1,000
to accommodate higher interest rates. It’s also possible that the loss relief rules could be relaxed, but not to the same extent as accrual accounting rules.
Should your business use cash basis accounting?
Larger businesses that aren’t eligible for the cash basis scheme must use other traditional accounting methods, but if your small business fits the eligibility criteria, you could opt in.
With this method, you would have to record income as payments received and expenses as business costs paid during the tax year – not including payments still owed. Even VAT-registered businesses can use cash basis if their annual income (including VAT repayments from HMRC) is £150,000 or less.
However, cash basis may not be suitable if you have plans to grow your business quickly, apply for business financing, or have more complicated operations (e.g. keeping high levels of stock). When you have a higher turnover or more stakeholders get involved, you’ll have to switch to accrual basis for a more accurate analysis of income and expenses.
If you’re transitioning from one type of accounting to another and need professional guidance, or need help getting your financial records in order, why not enquire at GBAC? Our accountants in Barnsley offer a range of services that could help your business operate smoothly and grow at your desired pace, including bookkeeping and VAT and cloud accounting.