As from 6 April 2013, small unincorporated businesses have the opportunity to calculate their profits using the cash accounting basis.
Small businesses have been required to compute their taxable profit in accordance with generally accepted accounting practice. The accounting practice includes calculating opening and closing debtors/stock, accruals and prepayments, and adjustments in respect of capital expenditure.
As the name suggests, profits under the cash accounting basis are calculated by deducting expenses of the trade paid during the basis period for the tax year, from the income of the trade received in that year. A few adjustments will still need to be made for tax purposes, but debtors and creditors are ignored, as well as accruals and prepayments.
This is clearly a much more straightforward approach, and businesses that operate with a high level of debtors or trading stock could potentially benefit from a cash flow advantage in the first year that they use the cash accounting basis.
To be eligible, the business must have a turnover not exceeding the VAT registration threshold (currently £79,000), and can continue to use the cash accounting basis until turnover rises to twice the entry threshold (i.e. £158,000). Limited Liability Partnerships are excluded, as well as partnerships that have an LLP or company as a partner. There are also specific exclusions for farming businesses that have adopted the herd basis, or made claims to average their profits.
Existing businesses may already have accounting systems in place, and switching to the cash accounting basis may not fit with these. Furthermore, business owners may feel that in order to manage their business effectively, they actually require a greater amount of detail that will not be provided under the cash accounting basis.
One distinct disadvantage of the cash accounting scheme is the inability to offset losses against other income. It is clear, therefore, that this scheme is unlikely to be suitable for new businesses where losses are likely to be incurred in early years, and the proprietor could potentially offset these losses against their other income. Cash accounting will not be suitable for all small businesses, but for many it does provide an opportunity which should not be overlooked.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
