Cash Basis Accounting in One Paragraph
Cash basis accounting means you record income when the money actually reaches you and expenses when you actually pay them. Traditional accounting, which HMRC's own guidance calls traditional accounting and the rest of the profession calls the accruals basis, records income on the date you invoice and expenses on the date you are billed, whether or not any money has moved.
That single difference is the whole thing. An invoice you raised on 20 March 2027 and got paid for on 12 April 2027 lands in the 2026/27 tax year under traditional accounting and the 2027/28 tax year under the cash basis. Same work, same money, different tax year.
Since 6 April 2024 the cash basis has been the default for sole traders and partnerships without corporate partners. You no longer opt in. You opt out.
The Change Most People Missed
Until the 2023/24 tax year, the cash basis was a small business concession. You had to elect into it, you could only use it if turnover was £150,000 or less, you had to leave once turnover hit £300,000, you could only deduct £500 of interest a year, and losses you made were stuck: no sideways relief, no carry back, carry forward only.
Schedule 10 of the Finance Act 2024 changed four things at once, with effect from 6 April 2024:
- The cash basis became the default. Section 31A ITTOIA 2005, which set out the conditions for using it, was simply removed. Eligible businesses are now on the cash basis unless they make an election under the new section 25C ITTOIA 2005 to use the accruals basis.
- The turnover limits went entirely. Not raised. Removed. There is no upper limit on the cash basis for a trade.
- The £500 interest cap went. Interest and finance costs incurred wholly and exclusively for the trade are now deductible in full.
- Loss relief was brought into line. A cash basis loss can now be used in the same ways as an accruals loss, including sideways relief against other income and carry back.
HMRC estimated around 250,000 businesses would move onto the cash basis as a result.
Here is the part that matters and that very little coverage picked up at the time. This is the first time a UK profit measurement basis has switched on by itself. If you had an accountant in 2024/25, someone made a decision on your behalf and ticked or did not tick a box. If you file your own return, the basis may have changed under you, in a year when a transitional adjustment was potentially due, and nothing on the screen shouted about it.
It also arrived one year after basis period reform finished forcing every unincorporated business onto a tax year basis. Two consecutive years, two structural changes to how the same group of taxpayers measures profit. That is a lot of moving parts for a population of people who mostly want to invoice, get paid, and not think about this.
Cash Basis vs Traditional Accounting: A Worked Example
Sarah is a freelance designer with a 5 April year end. In 2026/27 she invoices £82,000. Of that, £14,000 was invoiced in February and March and did not arrive until April and May. She also collected £6,000 in April 2026 for work invoiced in March 2026. Her costs for the year are £19,000, of which a £2,500 bill dated December was not paid until May.
| Traditional accounting | Cash basis | |
|---|---|---|
| Income | £82,000 | £74,000 |
| Expenses | £19,000 | £16,500 |
| Taxable profit | £63,000 | £57,500 |
Sarah is a higher rate taxpayer, so her marginal rate is 40% income tax plus 2% Class 4 National Insurance above £50,270. The cash basis defers £5,500 of profit, which is about £2,310 of tax she does not pay on 31 January 2028.
Note the word defers. She has not saved £2,310. She has borrowed it from next year, interest free, from HMRC. If her business stays roughly the same size, the £14,000 that rolled out of 2026/27 is replaced by a similar figure rolling out of 2027/28, and the benefit sits there as a permanent one year deferral for as long as she trades. If the business shrinks, she pays the difference back. If it grows, the deferral grows with it.
That permanent deferral is genuinely worth having. It is also the entire benefit, and it is smaller than people assume. The cash basis is a timing tool, not a relief.
Who Cannot Use the Cash Basis
The exclusions are structural rather than size based. You cannot use the cash basis for a trade if you are:
- a limited company
- a limited liability partnership
- a partnership with one or more corporate partners
- a Lloyd's underwriter
- a farming business with a current herd basis election
- a farming or creative business making a profit averaging claim
- a business that has claimed business premises renovation allowance in the last seven years
- a mineral extraction trade
- a business that has ever claimed research and development allowance
Limited companies are the one that catches people out. A company cannot use the cash basis at all, for any purpose, ever. Company accounts are prepared under FRS 102 or FRS 105 on an accruals basis because the Companies Act 2006 requires it, and corporation tax starts from those accounts. If you incorporated a sole trade that was on the cash basis, the company starts again on accruals from day one. That is a real and often unbudgeted consequence of going limited, because the switch pulls your debtors into charge sooner than you expect.
HMRC also lists a set of trades where the cash basis is permitted but usually a poor fit, including dealers in securities, ministers of religion, managed service companies, waste disposal businesses and cemeteries and crematoria. If you are in one of those, assume accruals unless someone has actually checked.
Three Different Cash Regimes, and They Are Not the Same Thing
This is where most of the confusion in our inbox comes from. There are three separate things in UK tax with cash in the name, they have different rules, different thresholds and different elections, and being on one tells you nothing about the others.
| Trading cash basis | Property cash basis | VAT Cash Accounting Scheme | |
|---|---|---|---|
| What it affects | Taxable trading profit | Taxable property profit | When VAT is due and reclaimable |
| Default since | 6 April 2024 | 2017/18 tax year | Never, you apply |
| Turnover limit | None | £150,000 of receipts | £1.35m to join, £1.6m to leave |
| Available to companies | No | No | Yes |
| How to opt out | Election under s25C ITTOIA 2005 | Election to use GAAP | Leave the scheme |
A few things fall out of that table that are worth saying plainly.
The property limit survived and the trading limit did not. A sole trader with a £3 million turnover can use the cash basis for the trade. The same person with a £160,000 rental portfolio is thrown off the cash basis for the property business. We have no idea why the £150,000 figure was worth keeping in one place and worth abolishing in another in the same period. If you have both a trade and a rental portfolio, you can easily be on two different bases at once and the tax return will let you do it without comment.
Jointly let property has a coupling rule. If you let property jointly with your spouse or civil partner, you have to use the same basis as each other. That catches a surprising number of couples who filed independently.
VAT cash accounting is a completely separate decision. You can be on the trading cash basis for income tax and standard VAT accounting, or accruals for income tax and the VAT Cash Accounting Scheme, or any other combination. The VAT scheme also carries restrictions the income tax basis does not: you cannot use it alongside the VAT Flat Rate Scheme, you cannot use it for invoices with payment terms of six months or more, and hire purchase, conditional sale and credit sale agreements stay outside it.
For a business that gets paid slowly, the VAT scheme is often the more valuable of the two, because VAT on an unpaid invoice is real money you hand over before you have it. Yet it is the one people have to apply for, so it is the one they do not do.
The Equipment Trap
This is the cash basis problem that costs the most money and gets the least attention.
Under the cash basis, most equipment is not a capital item at all. You buy a laptop, you deduct the laptop, in the period you paid for it. There are no capital allowances to claim because the spend is already an ordinary expense. Cars are the exception and still go through capital allowances, provided you have not claimed the HMRC mileage rate on the same vehicle.
For small purchases that is simpler and gives the same answer. The trap is finance.
A joinery business buys a £30,000 machine in June 2026 on a four year hire purchase agreement. Under traditional accounting the business owns the asset from day one and claims Annual Investment Allowance on the full £30,000 in the year of purchase. Under the cash basis, relief follows the payments. Roughly £6,250 of capital comes off in the first year, plus the interest.
| Traditional accounting with AIA | Cash basis | |
|---|---|---|
| Year one deduction | £30,000 | about £6,250 plus interest |
| Tax saved in year one at 42% | about £12,600 | about £2,800 |
The relief is not lost. It arrives over the four years of the agreement. But the year you commit to a £30,000 machine is almost always the year you would most like the tax back, and the cash basis is the one regime that will not give it to you. For any business that buys capital equipment on finance, this single point usually outweighs every timing advantage the cash basis offers.
When Traditional Accounting Is the Better Answer
The cash basis suits a business that is paid roughly when it works, holds little or no stock, owns little equipment, and is not trying to prove anything to a lender. That describes a great many sole traders, and for them the default is the right default.
It is the wrong answer in these situations.
You are buying equipment on finance. Covered above. This is the big one.
You carry stock. The cash basis has no stock adjustment, so you deduct stock when you pay for it rather than when you sell it. A retailer building inventory ahead of a busy season gets a large deduction in a quiet period and then a large profit in the busy one. It smooths nothing and it makes your own numbers harder to read. If you are trying to understand your gross margin or run management accounts, cash basis figures will not give you a straight answer.
You need to prove income to a lender. Mortgage lenders and brokers work from SA302s and tax year overviews, which show taxable profit. A growing business on the cash basis is showing a lower profit figure than the one it earned, by design. A consultancy growing 30% a year on 45 day payment terms might show £12,000 to £15,000 less profit than the accruals figure, every year, for as long as it grows. At a four and a half times income multiple that is roughly £60,000 of borrowing capacity, quietly given away in exchange for deferring a few thousand pounds of tax. Almost nobody prices this in before they apply.
Your business is lumpy. Large projects billed and paid across a year end can throw profit from one tax year into another in a way that pushes you over the £50,270 higher rate threshold in one year and wastes your allowances in the next. Accruals does not eliminate that, but it does not amplify it either.
You want the numbers to mean something. This is the point we care about most. Cash basis accounts are tax computations. They are not a picture of the business. They do not show you what you are owed, they do not show you what you owe, and they will not tell you whether you had a good year. If you want to run on the numbers rather than just file them, you need trade receivables, trade payables and accruals and prepayments in there, which means traditional accounting.
Plenty of our clients keep proper bookkeeping on the accruals basis all year for management purposes and then file on the cash basis. Those two things are not in conflict. The basis you file on is a tax election, not a description of how you have to run your books.
Our View: It Rewards the Wrong Behaviour
Here is the thing that bothers us about the cash basis as a default, and we have not seen anyone else make the point.
The cash basis gives the biggest tax advantage to the business that is worst at getting paid. Money sitting in your customers' accounts on 5 April is money you are not taxed on. The business that chases invoices well, gets paid on 14 day terms and keeps its debtor days low gets almost no benefit at all. The business with £40,000 of overdue invoices and no credit control gets a large deferral, and the worse the problem gets, the larger the deferral grows.
At the same time it penalises paying your suppliers. An unpaid bill on 5 April is not deductible, so a business that settles supplier invoices promptly loses the deduction it would have had under accruals. The tax system is now, very mildly, paying you to be slow and charging you to be prompt.
Nobody runs a business around a few hundred pounds of timing. But defaults matter, and a default that quietly rewards weak cash collection is an odd thing to give 250,000 small businesses at the same time as everyone in the country agrees late payment is strangling them. We would rather HMRC had kept the cash basis opt in and spent the simplification effort somewhere with fewer side effects.
There is a second oddity worth naming. Removing the turnover cap entirely means the cash basis, designed for the window cleaner and the mobile hairdresser, is now available to a sole trader turning over £10 million. ICAEW flagged at the time that the relief could in principle extend to some very large businesses. That is not a scandal, because very large unincorporated businesses are rare and mostly have advisers who will elect out. It does tell you that the limit was removed for administrative tidiness rather than because anyone thought about the top of the range.
What the Treasury Numbers Say
The costing in HMRC's own policy paper is the most honest description of this measure anywhere.
| Year | Exchequer impact |
|---|---|
| 2024 to 2025 | nil |
| 2025 to 2026 | +£115 million |
| 2026 to 2027 | -£30 million |
| 2027 to 2028 onwards | nil |
Read that as a whole. The measure raises money briefly, gives some back, and then costs nothing at all. Our reading is that the early gain comes from businesses moving onto the cash basis and picking up a transitional adjustment on the way in, which pulls tax forward, and the give back is the deferral effect settling down afterwards.
Whatever the exact mechanics, the shape of the table is the story. This was never a tax cut. It is an administrative simplification with a rounding error attached, and if anyone tells you the cash basis will reduce your tax bill, the Treasury's own scorecard says otherwise over anything longer than a couple of years.
How to Opt Out
For a trade, you make an election under section 25C ITTOIA 2005 to use the accruals basis. In practice that means ticking the box on the self employment pages of your Self Assessment tax return that says you used traditional accounting. For a property business, you tick the equivalent box on the property pages.
The deadline is the normal amendment window: one year after the 31 January filing date for that tax year. For the 2025/26 tax year, that means 31 January 2028. For 2026/27, 31 January 2029.
Two things to know about the election:
- It applies from the tax year it is made, onwards. It is not a one off. You stay on the accruals basis until you withdraw it.
- It can be withdrawn, which lets you move back to the cash basis later. So it is not a one way door in the way that some tax elections are.
If you have been filing your own returns since 2024/25 and have never thought about this, it is worth ten minutes to look at which box is ticked on the last two returns, and whether that matches what you believe you have been doing.
Leaving Is Harder Than Joining
This is the point at which people get an unwelcome letter, so it deserves its own section.
When you leave the cash basis, section 231 ITTOIA 2005 requires a transitional adjustment so that income is taxed once and only once. In broad terms, you add up what customers owed you and the stock you held at the end of the last cash basis period, then subtract what you owed suppliers and any income received in advance.
- If the result is positive, that is adjustment income. It is spread over six tax years, one sixth a year, starting with the first period after you leave. You can elect to accelerate it.
- If the result is negative, that is an adjustment expense, deducted in full in that first period. No spreading.
The six year spread is generous and it is also six years of a figure sitting on your tax return that has nothing to do with the year you are in. For a business with, say, £90,000 of debtors at the point of switching, that is £15,000 of extra taxable income a year for six years, on top of whatever it actually earns.
So the sequence to avoid is: drift onto the cash basis because it is the default, grow for five years, then discover you need accruals accounts for a lender or a sale, and pick up a six year adjustment at exactly the moment your profits are highest. If you can see growth coming, it is usually cheaper to elect out early, while the debtor balance is small, than to unwind it later.
Making Tax Digital Brings This Decision Forward
Making Tax Digital for Income Tax started in April 2026 for anyone with qualifying income over £50,000. The threshold drops to £30,000 from April 2027 and £20,000 from April 2028. Around 780,000 people were in the first wave, with roughly another 970,000 joining in the second.
Under MTD you file quarterly updates from digital records rather than one annual return. That changes the calculus in two directions at once.
Quarterly reporting is genuinely easier on the cash basis, because a cash basis quarter is close to a list of bank transactions, while an accruals quarter needs cut off judgements four times a year instead of once. HMRC clearly had this in mind, and it is a fair point.
Against that, a basis that was previously visible once a year is now baked into a process you touch every three months, and mistakes replicate. If you are on the wrong basis, MTD means you are now on the wrong basis four times a year.
Our advice to anyone coming into MTD is to settle the basis question before the first quarterly update, not after. It is much easier to start a digital record keeping regime on the right footing than to reconstruct one.
How IAK Can Help
We act for sole traders, contractors, landlords and small businesses across North London and Hertfordshire, and the basis question comes up in almost every first conversation, usually because nobody has ever raised it.
It is normally a short piece of work. We look at your last two returns to establish which basis you have actually been filing on, run your numbers both ways, and tell you whether the difference is worth acting on. For a lot of people it is not, and we will say so. For anyone buying equipment on finance, applying for a mortgage in the next two years, carrying stock, or growing quickly, it usually is.
If you are coming into Making Tax Digital, we would rather have that conversation now than in your first quarter. Get in touch, or read more about our accounting, bookkeeping and tax planning services.
Sources
- Cash basis: overview, GOV.UK, for the cash basis being the standard way sole traders and partnerships without corporate partners record income and expenses.
- Who can use cash basis, GOV.UK, for the full list of excluded business types and the trades for which the cash basis is permitted but unsuitable.
- Income and expenses under cash basis, GOV.UK, for equipment other than cars being claimed as a normal allowable expense rather than a capital allowance, the car exception, and the VAT consistency rule.
- Expanding the cash basis, HMRC policy paper, for the four changes from 2024/25, the estimate of 250,000 businesses moving onto the cash basis, and the Exchequer impact figures.
- Finance Act 2024, Schedule 10, legislation.gov.uk, for the omission of section 31A ITTOIA 2005 and the new election under section 25C ITTOIA 2005.
- Cash basis changes from the 2024/25 tax year, ACCA, for the removal of the £150,000 entry and £300,000 exit limits, the removal of the £500 interest cap, and the alignment of loss relief.
- BIM72030: cash basis expenses overview, HMRC Business Income Manual, for relief not being given until a payment is made and capital allowances not being available under the cash basis except for cars.
- BIM72071: transitional adjustments on leaving the cash basis, HMRC Business Income Manual, for the section 231 ITTOIA 2005 calculation, the six year spread of adjustment income and the immediate deduction of an adjustment expense.
- PIM1092: cash basis for landlords overview, HMRC Property Income Manual, for the £150,000 receipts limit, the cash basis being the default for property businesses since 2017/18, the jointly let property rule and the one year election deadline.
- VAT Cash Accounting Scheme, GOV.UK and its eligibility rules, for the £1.35 million joining threshold, the £1.6 million exit threshold and the excluded transactions.
- Find out if and when you need to use Making Tax Digital for Income Tax, GOV.UK, for the April 2026, April 2027 and April 2028 thresholds and the numbers of people in each wave.