Which method to choose?
When you are self-employed or a partnership you can calculate your profits on two bases.
From the 2013–14 tax year, you can choose to start using the cash basis. Cash accounting, like the name implies on the basis of cash received and expenditure made. Traditional accounting (accruals basis) is on the basis of invoices sent and invoices received regardless of whether payment has been made or not.
This is a simpler way of working out your business profit or loss as you record money when it actually comes in and goes out of your business.
But the treatment of certain items is different, unlike traditional accounting;
- payments for equipment, including vans, are allowable expenses.
- there is a maximum of £500 allowable as an expense for interest paid on cash borrowings.
- any losses you make can’t be set off against your other income
- you can’t claim capital allowances for anything except cars.
To use cash accounting your turnover must be £79,000 or less for the year. This increases to £158,000 if you claim Universal Credit.
Traditional Accounting (accruals basis)
Traditional accounting is not the same as cash basis accounting. Cash basis records money when it actually comes in and goes out of your business, traditional accounting records income and expenses when you invoice your customers or receive a bill.
Records you must keep under traditional accounting:
- all your sales and takings (income)
- all your purchases and expenses.
This might include:
- business assets you’ve bought (for example, stock or equipment)
- value of stock and work in progress at the end of your accounting period
- details of payments to employees (for example, wages, expenses or benefits)
- business vehicle and travel costs
- interest from any bank or building society accounts
- other money coming in, such as; money you invest in your business.
If you are using traditional accounting, only include business expenses in your accounts if they belong to that accounting period. If you make a payment which covers more than one accounting period, you need to spread the cost over the periods that they belong to. For example, if you pay 12 months’ rent in advance halfway through a year; only include half of the payment in that year’s accounts. Include the other half in the next accounting period.