Updated on 19 July 2021
The difference between those two methods are how you are taxed (from income and expenses) in the end.
With cash basis method for example, if you have separate business account for all your business transactions, the balance at your year end should be the same as your net income, because you have recorded your bookkeeping transactions the same way, CASH IN – CASH OUT. It will only differ, if you use car for your business, because car expenses calculate different way and if you paid interest for bank loans, because there is max £500 allowed as business expense. With cash basis method, you should have enough money at your bank account to pay your tax bill at your year end.
With traditional accounting method, it can often happen, that you are recording sales which haven’t been paid and you are taxed on those sales, but you might not have enough money to pay tax bill, because you haven’t received money yet from your clients. But on the other hand, if you record expenses, which you haven’t paid yet, you will be taxed less in that year. But everything will balance next year and as you go on. But there might be big differences between cash you have and tax you pay with invoices which have bigger value.
With cash basis, only record income you actually received in a tax year. Don’t count any money you’re owed but haven’t yet received.
You can choose how you record when money is received or paid (for example the date the money enters your account or the date a cheque is written) but you must use the same method each tax year.
All payments count – cash, card, cheque, payment in kind or any other method.
Expenses are business costs you can deduct from your income to calculate your taxable profit. In practice, this means your allowable expenses reduce your Income Tax.
Only count the expenses you’ve actually paid. Money you owe isn’t counted until you pay it.
Examples of allowable business expenses, if you’re using cash basis are:
- day to day running costs, such as electricity, fuel,
- admin costs, for example stationery,
- things you use in your business, such as machinery, computers, vans,
- interest and charges up to £500, for example interest on bank overdrafts buying goods for resale.
Cars and other equipment
If you buy a car for your business, you can claim buying and running costs of your car through simplified expenses, Flat rate expenses.
You claim other equipment you buy to keep and use in your business as a normal allowable business expense.
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