Managing your business finances can be challenging, especially when tax rules and accounting terms feel more complex than they should be. That’s why cash basis accounting has become increasingly popular, and as of the 2024/25 tax year, it’s now the default method for most self-employed individuals in the UK.
In simple terms, the cash basis method helps you focus on what really matters: the money actually in your bank account. It’s a straightforward way to record income and expenses, giving you a clear picture of your real-time cash flow without getting lost in complicated accounting adjustments.
Whether you’re a freelancer, sole trader, or small business owner, this guide will walk you through everything you need to know about cash basis accounting, including how it works, how it compares to traditional accrual accounting, and how recent HMRC updates could make managing your finances easier than ever.
What Is Cash Basis Accounting?
Cash basis accounting is a simplified way of recording your business income and expenses. Instead of tracking when you issue invoices or receive bills, you only record transactions when the money actually moves, that is, when cash is received or payments are made.
For example:
- If you send an invoice for £500 in April but get paid in May, you record the income in May.
- If you buy supplies in March but pay the bill in April, you record the expense in April.
This method gives you a direct view of how much money you truly have at any moment, perfect for managing cash flow without worrying about complex accruals, prepayments, or outstanding invoices.
It’s worth noting that “cash” doesn’t mean you have to deal in notes and coins. It includes bank transfers, card payments, PayPal receipts, and even cleared cheques.
From 6 April 2024, HMRC made the cash basis the default accounting method for self-employed taxpayers and partnerships, a major change aimed at making tax reporting simpler and more accessible for small businesses.
How Cash Basis Accounting Works (With Examples)
Under cash basis accounting, income and expenses are recognised only when they physically happen. You don’t need to account for unpaid invoices or bills, which keeps bookkeeping much simpler.
Example 1: Recognising Income
Jane runs a small bakery. She invoices a local café £500 in June for a batch of pastries, but the café doesn’t pay until July.
👉 Under cash basis accounting, Jane records the £500 as income in July, when the payment is received, not when the invoice was sent.
Example 2: Recording Expenses
Tom, a freelance designer, receives a £60 bill for his website hosting in May but pays it in June.
👉 He records this £60 expense in June, when the payment is actually made.
This system focuses purely on cash movement, not accounting periods. It reflects your real financial position and helps you see what’s available to spend, save, or reinvest.
However, businesses must be consistent in how they recognise payments — for instance, whether you record cheque income when it’s received, banked, or cleared. HMRC doesn’t enforce strict timing rules, but it does require you to apply your chosen approach consistently.
General Principles Under HMRC’s Cash Basis (2025 & Onwards)
With HMRC’s 2024 reforms, the cash basis has become the default system for sole traders and partnerships. Here’s what that means in practice:
- Income and expenses are recorded when paid or received, not when invoiced.
- You no longer need to calculate debtors, creditors, or prepayments at year-end.
- No stocktake or valuation adjustments are required.
- You can still keep simple digital records through bookkeeping software or spreadsheets.
- Businesses are expected to maintain proper records for accurate Self Assessment returns.
This change was designed to reduce administrative burden and help small business owners focus on growing their businesses rather than juggling accounting complexities.
Eligibility Criteria for Using the Cash Basis
One of the biggest updates from HMRC for the 2024/25 tax year is that there are no longer turnover limits or thresholds for using the cash basis.
Here’s what you need to know about eligibility:
- Default method: For self-employed individuals and partnerships, the cash basis is now automatically applied unless you opt out and choose accrual accounting instead.
- No turnover restrictions: Previously, the limit was £150,000 turnover to enter and £300,000 to stay in the scheme. Those limits have now been removed.
- Multiple businesses: You can use a cash basis for one business and accrual for another.
- Partnerships: Each partnership can now decide individually whether to use the cash basis.
- Universal Credit claimants: Still report income to the DWP monthly, but HMRC cash basis rules apply separately for tax.
Limited companies, trusts, and certain partnerships with corporate members cannot use the cash basis method.
These changes make it easier for small business owners, freelancers, and side hustlers to handle their taxes without hiring an accountant or managing complex systems.
Cash Basis Accounting vs Traditional (Accrual) Accounting
What Is Accrual (Traditional) Accounting?
Accrual, also known as traditional accounting, recognises income when it’s earned and expenses when they’re incurred, regardless of when money changes hands. This approach gives a more accurate picture of long-term performance but is often more time-consuming.
Key Differences Between Cash and Accrual Accounting
| Feature | Cash Basis | Accrual (Traditional) Basis |
| When income is recorded | When received | When invoiced or earned |
| When expenses are recorded | When paid | When incurred |
| Complexity | Simple | Detailed and technical |
| Best for | Small or self-employed businesses | Larger or growing businesses |
| Tax timing | Based on payments received | Based on invoices raised |
| HMRC Default (2024/25 onwards) | ✅ Yes | ❌ Optional |
Which Method Is Better for You?
The right choice depends on your business goals and complexity:
- Cash basis accounting is ideal if you want simplicity, manage your own books, or have straightforward income and expenses.
- Accrual accounting is better if you’re seeking business loans, managing stock, or want a detailed financial analysis.
- Some businesses use a hybrid approach, a cash basis for tax simplicity, and an accrual basis for management and forecasting.
If you’re unsure, consult an accountant to evaluate which method aligns best with your financial needs and reporting requirements.
Benefits of Cash Basis Accounting
Cash basis accounting comes with several advantages, especially for small businesses and self-employed individuals:
- Simpler bookkeeping: No need to track unpaid invoices or bills.
- Clear view of cash flow: Know exactly how much money is available at any time.
- Lower administrative costs: No need for complex accounting systems or professional accountants for day-to-day records.
- Better alignment with cash availability: You only pay tax on money you’ve actually received.
HMRC 2024/25 reforms make it more flexible:
- No cap on interest deductions.
- Loss relief rules now match accrual accounting.
- Separate accounting choices are allowed for multiple businesses.
For small traders and freelancers, this method provides a real-time snapshot of financial health, a straightforward, less stressful way to manage business finances.
Disadvantages of Cash Basis Accounting
While cash basis accounting simplifies record keeping, it isn’t the right choice for everyone. There are several drawbacks that businesses should consider before fully committing to this method:
- Less accurate long-term reporting: Because income and expenses are only recorded when money changes hands, your profits can appear higher or lower than they actually are.
- Not suitable for complex or growing businesses: If your business deals with inventory, long-term contracts, or financing, the accrual method may provide a clearer financial picture.
- Harder to forecast trends: Since it doesn’t record outstanding invoices or bills, it’s more difficult to analyse performance or plan ahead.
- May hinder financing opportunities: Lenders and investors often prefer accrual-based financial statements for accuracy and comparability.
- Potential for misleading results: For instance, if you receive several late payments at once, it could make a weak month appear unusually strong.
In summary, cash basis accounting works best for simple, cash-driven businesses. But if you need a detailed understanding of your business’s financial performance, accrual accounting may be the more reliable choice.
Examples of Cash Basis Accounting
Let’s look at a few examples to show how this accounting method works in practice:
1: Harry’s Sports Equipment Business (HMRC Example)
Harry is a self-employed sports equipment retailer who prepares accounts to 5 April each year.
- He sells 100 footballs in March 2024 for £700 but is paid on 20 April 2024.
👉 This £700 is included in his accounts for the year ended 5 April 2025. - He buys 12 table tennis tables in December 2024 and pays immediately.
👉 The cost of all 12 is recorded as a purchase for the year ended 5 April 2025, even though six remain unsold. - He pays annual vehicle insurance on 1 January 2025.
👉 The full payment is an expense for 2024/25, even though the policy covers part of 2025/26.
This example shows how cash basis simplifies bookkeeping; there’s no need for stock valuation, prepayments, or accrual adjustments. Everything is recorded when cash moves.
2: Construction Company on a Long-Term Project
A construction company secures a large contract but won’t be paid until completion the following year.
👉 Under cash basis accounting, the company recognises no revenue until payment is received.
This could make its financial statements appear loss-making one year and highly profitable the next, even though the project’s performance has been steady.
This example highlights one of the main weaknesses of cash basis accounting for long-term projects: it can distort results over time.
Special Rules for Expenses, Interest, and Trading Losses
The 2024/25 HMRC reforms simplified how specific items are treated under the cash basis. Here’s a breakdown:
Expenses
Most capital items (such as tools and equipment) can be treated as direct expenses, reducing taxable profit immediately.
However, land, buildings, and cars are exceptions; cars still qualify for capital allowances instead.
Interest and Finance Costs
Before April 2024, businesses could only claim up to £500 per year in interest deductions.
Now, this restriction has been completely removed, aligning cash basis with accrual accounting rules.
Trading Losses
Previously, losses could only be carried forward to offset profits from the same business.
From 2024/25 onwards, loss relief rules are the same as under the accrual method, giving businesses more flexibility when managing downturns.
These updates make the cash basis a more practical option for a broader range of businesses.
Switching from Cash Basis to Accrual Accounting
If your business grows or your finances become more complex, you might decide to move from the cash basis to the accrual basis.
HMRC provides transitional rules to ensure you don’t double-count or omit income and expenses during the changeover.
Key Steps When Switching:
- In your first year on the accrual basis, you’ll need to identify any transactions that were previously unrecorded under the cash basis.
- Adjust for any overlap in income or expenses to make sure your taxable profit remains accurate.
- The resulting tax adjustment is spread over six years, unless you choose to shorten the period.
Switching is perfectly acceptable, and often advisable, once your business requires more detailed reporting, financial analysis, or funding.
Summary
Cash basis accounting offers a simple, efficient, and now default way for small UK businesses to manage their finances. It’s designed for ease of use, focusing on real money movement rather than accounting theory, helping you save time, stay organised, and keep on top of cash flow.
However, it’s not a one-size-fits-all solution. If your business is expanding, manages inventory, or needs detailed reports for investors or lenders, the accrual basis may be more appropriate.
The key is to choose the system that reflects your business needs today and supports your goals for tomorrow.
👉 Need help choosing the right accounting method?
Speak to a qualified accountant or tax adviser from Sigma Chartered Accountants & Tax Advisors who can guide you on which approach best suits your business, especially under the latest HMRC 2025 rules.
FAQs
Q: Is cash basis accounting compulsory in 2025?
Ans: No, it’s now the default for self-employed individuals and partnerships, but you can opt out if you prefer the accrual method.
Q: Can limited companies use the cash basis?
Ans: No. The cash basis is only available to unincorporated businesses, such as sole traders and partnerships.
Q: Do I still need to keep records under the cash basis?
Ans: Yes. You must still maintain accurate records of all income and expenses to support your Self Assessment tax return.
Q: Can I use cash basis accounting if I claim Universal Credit?
Ans: Yes, but be aware that Universal Credit reporting follows slightly different rules to HMRC’s cash basis.
Q: Can I use cash basis for one business and accrual for another?
Ans: Yes. From April 2024, you can use different accounting methods for each of your businesses.
Q: When should I switch to accrual accounting?
Ans: If your business grows, manages stock, or requires loans or investment, switching to the accrual method can provide a clearer financial overview.
