Cash Accounting: The emphasis of cash accounting is on the flow of cash i.e. recording transactions when the money is received and when it goes out, so transactions will mirror what’s in the bank statement; and you only pay tax on basis of cash flow.
Accrual Accounting: The focus of accrual accounting is on entitlement and obligation i.e. recording transactions when the entitlement occurs and when the liabile for an expenditure e.g. record a sales invoice when it’s generated (even if cash hasn’t been received) and a purchase invoice when received (even if payment hasn’t been made). In this case, you could potentially end up paying tax on income not yet received.
Which is Better? It depends! Let’s examine what it depends on.
Who can use cash accounting: It depends on whether you are legally allowed to operate cash accounting or not! According to HMRC’s rules you can only operate cash accounting if:
- You are a self – employed business i.e. sole traders or partnerships
- Your turnover is no more than £150k
If the above doesn’t apply, then it isn’t a choice, you’ll have to operate on traditional accounting basis. This means all corporate organisations (i.e. limited liability companies and partnerships) are required to operate traditional accounting.
So, for sole traders who qualify (i.e. the above criteria apply), which is better? Again it depends! So let’s consider the below.
Simplicity: Cash accounting is a simple way of operating your accounts since you only have to record transactions based on actual cash flow. It also means you only get taxed on income that has been received. So, if you are looking for a simple way to keep your books, then cash accounting would be better.
Flipside of simplicity: However, operating on cash accounting basis won’t show a full picture of the business’s financial health so any financial information generated won’t be useful for making meaningful management decisions, unless additional compuations are made. Cash accounting based financial information would also, not be acceptable when seeking finance from a bank.
So ultimately, which is better depends on whether you are a corporate organisation or not, your turnover, whether you are a new or growing business and the purpose of financial reports generated.
If you’re unsure which is best, contact us at BAnC Services, we’ll be happy to support you with making a decision that’s right for you!