Cash basis vs traditional accounting
No matter how quick your clients are to settle invoices, there’s always a delay between issuing the invoice and receiving payment. If you’re lucky, this might be a few hours or a couple of days, but some clients will demand payment terms of 30 days or more.
Aside from the impact on your cashflow, this poses a question for your accounting: when do you pay tax on that money? Is it when the invoice is issued, or when your receive the money?
If you’re a sole trader, you can decide whether to:
- Pay tax based on the dates that invoices/expenses are issued (‘traditional accounting’)
- Pay tax based on when the money enters/leaves your account (‘cash basis’)
Tax on money in/out #
The other advantage of the cash basis is that you only pay tax on the money you’ve actually received or spent. Under traditional accounting, you would pay tax on an invoice issued but not paid before the end of your tax year.
For instance, let’s say your tax year ends on 31st March and you issued an invoice on the 30th March. The invoice isn’t paid until the 12th April.
Under traditional accounting, you would be taxed on this amount, even though the money hadn’t been received. You wouldn’t be taxed on this amount when using the cash basis.
In the grand scheme of things, this is unlikely to have a huge impact on a tax bill. But, in some cases it might mean paying tax on an invoice that’s never paid, only to have write it off a year later.
Cash basis & accounting software #
Cash basis accounting isn’t supported by some accounting software.
If you’re not using accounting software to submit your returns, this won’t affect you, but this is worth knowing. If you want to submit your own accounts through your software, ask about this before you sign up.