There are many decisions that need to be made when starting your own business. One is the use of cash accounting or traditional accounting. An accountant will recommend the best method for your business, but it can not hurt!
Traditional Accounting
Traditional accounting is sometimes referred to as accrual accounting or accrual. With this billing method, you must record every invoice you send and receive, whether it is paid or not. It also means that you pay income tax even if the customer has not paid you.
Example of Traditional Accounting
Invoice to a customer at the end of March 2021 (the financial year 2020-2021). You will receive this invoice in May 2021 (the fiscal year 2021-22). The invoice is posted for the financial year 2020-2021 and not for the financial year 2021-2022.
Traditional accounting requires that you keep track of all income and expenses. These can be:
- All assets in the acquired company (shares and equipment)
- The value of the shares at the end of their accounting period
- Payments to employees (salaries, bonuses, benefits, etc.)
- Travel expenses and company cars
- Interest from a bank or mortgage bank
- Indicate other income
Traditional accounting is generally fine for large companies, but it is worth considering, especially if you expect your business to grow rapidly.
Cash Basis Accounting
Cash-based accounting is generally best for small businesses with a turnover of £ 150,000 * or less. You can continue to use cash as your business grows and reaches a total turnover of € 300,000 * per year.
Unlike traditional accounting, companies that use cash basis accounting only record invoices and expenses when they are actually paid. It also means that you do not pay income tax until your client pays you.
Example of Cash Accounting
Invoice to a customer at the end of March 2021 (the financial year 2020-2021). You will receive this invoice in May 2021 (the fiscal year 2021-22). The invoice is posted for the financial year 2021-2022 and not for the financial year 2020-2021.
The processing of some items also varies depending on the type of bookkeeping used. E.g.
- Team payments are eligible expenses
- The maximum interest rate on the advance is £ 500.
- You can not set off losses in your other income
- No capital reduction can be requested for goods other than cars.
Which Method to Choose?
If you are self-employed or have a partnership, you can calculate your profit in two ways.
From the assessment year 2021-22, you can choose to use the cash basis. Cash accounting as the name implies based on cash received and expenses incurred. Traditional accounting (accounting basis) is based on invoices sent and invoices received, regardless of whether payment has been made or not.