Self-employed: cash basis or traditional accounting?

When you register as self-employed with HMRC you’ll have to choose which type of accounting you prefer: cash basis or traditional.

Cash basis is suitable for most self-employed people. It’s simple and makes your taxes easier to declare.

Nonetheless, let’s have a quick look at the differences!

Traditional accounting

This is when you record your income and expenditure regardless of whether or not you’ve actually been paid for the work. Basically, you use your invoices instead of bank statements to record your income. This is known as accrual-based accounting.

Confused? Luckily we’ve got an example. But first, here’s how the tax year works – dates, deadlines, the whole shebang.

So now, how accrual-based accounting works.

• You invoice a customer on March 25th
• The customer pays you on April 18th
• April 18th falls into a different tax year from when you invoiced
• Accrual-based accounting means you file based on when you invoiced, not when you’re paid

There are a few advantages to the traditional accounting method:

• You can offset losses 
• It’s easier to deal with VAT

Cash basis accounting

This method is actually much more simple and particularly ideal for those who run a small business. Sole traders will also benefit from cash basis accounting. 

All you have to do is record your income or expenses when you actually receive or pay money into your bank. Now come the end of the tax year, you will only pay income tax on money received in your accounting period.

Let’s look at the same scenario now, but using the cash basis accounting method:

• You invoice a customer on March 25th
• The customer pays you on April 18th
• April 18th falls into a different tax year from when you invoiced
• Cash basis accounting means you file based on when you’re paid

FYI: You can still claim capital allowances and allowable business expenses when using cash basis accounting. Find out more about what is generally accepted here.

The Simplified Expenses Scheme

This is a way of calculating some of your business expenses using flat rates. You can choose this only if you also use cash basis accounting.

You can use flat rates for:

• Your car (the mileage allowance) 🚗
• Working from home (the home office allowance) 🏠

Read more details about these flat rates here.

For everything else, working them out as you would normally should do the trick!

Which one should you choose?

Of course, different methods work differently for everyone but we think this time cash basis accounting takes the winning spot. It’s just so much more simple and who doesn’t love simplicity?

🚨 Bear in mind though, if your earnings from self-employment are over £150,00 – you can use traditional accounting only. In this case, we’d recommend setting up a limited company instead. 🚨