Cash basis vs traditional accounting: which applies to you now

What the two methods mean

For a service business paid promptly, the two produce similar answers. The differences show up around year end: under the cash basis an invoice issued in March but paid in May falls into the next tax year, which is both simpler and often kinder to cashflow.

What changed in 2024/25

Three restrictions that used to make the cash basis a compromise were removed when it became the default for sole traders and partnerships without corporate partners:

• The turnover limits are gone. Previously you had to leave the scheme as receipts grew; now a business of any size can use it.
• The £500 cap on interest deductions was removed; loan interest incurred wholly and exclusively for the trade is deductible in full.
• Loss relief was aligned with accruals: cash-basis losses can now be set sideways against other income or carried back on the same footing.

On the return, the position is inverted from the old days: you now tick a box to say you used traditional accounting. Do nothing, and cash basis applies.

Who should still opt out

Accruals remains the right choice, or the only choice, in a minority of cases:

• Not eligible at all: limited companies, LLPs, partnerships with corporate partners, and some specialist cases such as farmers using herd basis or averaging claims.
• Businesses that need GAAP accounts anyway, for example for a lender or investors: keeping two sets of books rarely pays.
• Businesses claiming reliefs the cash basis excludes, or with significant stock, work-in-progress or long payment cycles where accruals gives a truer, steadier profit figure.

A worked example: the same year on both bases

Priya, a freelance designer, raises £32,000 of invoices during the year. At 5 April, £4,000 of them are still unpaid. She incurs £6,000 of costs, of which a £900 supplier bill is itself unpaid at year end.

The £3,100 gap is timing, not magic: the unpaid invoices and the unpaid bill fall into next year's cash-basis figures when the money finally moves, and over the life of the business both methods tax the same total profit. What differs is when, and the cash basis has the kinder cashflow logic: Priya is not paying tax in January on £4,000 that nobody has yet settled. The reverse is worth noticing too. In a year when large invoices from the previous March all land in April, the cash basis can make a modest year look busy, which feeds through to payments on account.

Landlords: similar idea, different rules

Property businesses have had their own cash basis as the default since 2017/18, but the 2024/25 trader reforms did not apply to it. For landlords, the cash basis does not apply where cash receipts exceed £150,000 in the year, where the business is run through a company, LLP or trust, or where you elect to use GAAP instead; that election must be made within a year of the filing deadline for the tax year. Most individual landlords are simply on the cash basis without ever thinking about it.

What this means for your records

The cash basis makes a business bank statement remarkably close to a tax record: money in and money out on the dates shown are, mostly, your taxable income and allowable expenses. That is the model our free bank statement analyzer is built around: it extracts each transaction, dates it, and categorises it against the SA103 headings, which under cash basis is most of the work of a return. The caveats are the usual ones: personal spending must be excluded, capital items may need different treatment, and transfers between your own accounts are neither income nor expense.

Frequently asked questions

Can I switch between methods each year?

You choose per year on the return, but switching triggers transitional adjustments so income is not taxed twice or missed. Switch when there is a real reason, not tactically each year.

How does VAT interact with the cash basis?

They are separate regimes. A VAT-registered business can use the income tax cash basis and either standard or cash accounting for VAT; the records just need to keep the strands clear.

Does Making Tax Digital change any of this?

No. MTD changes how and how often you report, not how profits are calculated. Quarterly updates carry whichever basis you use.