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The cash basis is a term used to describe a method of calculating your income and expenses. It’s one of the most common types of accounting that you can use when you’re self-employed.
Using cash basis accounting, you can calculate your profits based on when cash exchanges hands (or when it’s paid) rather than using the date you invoice a client. You might prefer to do this because being paid inconsistently can be common when you’re self-employed; having to chase late payments is an unfortunate reality.
As a result, you can end up being taxed on money you’ve not actually received yet.
The main disadvantage to tracking your income and expenses based on when you actually receive the money is that it can make your business appear more thriving than it actually is.
If, for some reason, all your clients dating back four months all pay you in May, your yearly takings will be skewed. For the previous tax year, they will appear too low; for the new tax year, they’ll be too high.
In terms of your tax bill, you shouldn’t be impacted too much by this. But you might be impacted when it comes to providing accurate records when you seek investment for your business.
You should also be mindful of paying for business expenses by credit card when you account using cash basis. This is because you actually pay for the expense not at the point of sale but when you pay your credit card bill.
Most self-employed people can use cash basis accounting, but there are some exceptions. Click to see if you can use cash basis accounting.
And take a look at how it works when you’re self-employed:
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