For smaller firms and sole traders, simplicity is often best. That simplicity can often be compromised by terminology that seems designed to confuse. Accountants do that – but here we can simplify the language that explains how we can simplify your financial reporting.
Cash basis accounting is a method of recording income and expenses when they are actually received or paid, rather than when they are earned or incurred. This approach provides a straightforward overview of your business’s cash flow, making it a popular choice for small businesses and freelancers.
Cash basis accounting works like this:
- Income Recognition: Revenue is only recognised when cash is received. For example, if a customer places an order but doesn’t pay until the following month, the income won’t be recorded until the payment is made.
- Expense Recognition: Expenses are only recognised when cash is paid out. This means that if you purchase supplies on credit, the expense won’t be recorded until you pay the bill.
The advantage lies in the simplicity – it’s relatively easy to understand and implement, especially for small businesses with limited accounting knowledge, and it provides a clear picture of your business’s cash flow, which is essential for managing day-to-day operations, while focussing on the timing of cash inflows and outflows, which is often more relevant to small businesses than accrual accounting.
The disadvantage is that it can provide a less accurate picture of your business’s financial performance, as it doesn’t account for revenues earned but not yet received or expenses incurred but not yet paid.
In some cases, cash basis accounting can provide misleading information about your business’s financial health, as it doesn’t reflect the full economic activity of the period.
It’s a choice to make, but the cash basis approach is often a good choice for:
- Small businesses: It’s relatively simple to implement and provides a clear view of cash flow.
- Freelancers: Freelancers often have irregular income streams, making cash basis accounting a practical option.
- Businesses with limited accounting resources: It requires less complex record-keeping than accrual accounting.
But it may not always be the best way long term – if your business grows or needs to comply with specific accounting standards, you may need to switch from cash basis to accrual accounting.
The choice you make is significant to the way you keep records and report in to HMRC – and switching to other approaches can be complex.
So get in touch and let’s work out the best way for you.
