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Cash-Based Accounting – a Revolution for Small Businesses?

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Thursday April 12, 2012 at 9:00am
The 2012 Budget saw George Osborne present a shiny new present for small businesses: cash-based accounting. From April 2013, very small businesses with a turnover up to £77,000 (the 2013 VAT threshold) will be able to submit their accounts on the basis of cash passing through the business.

The principle behind this move is one which drives many Government policies – simplification. Cash-based accounting removes a great deal of complexity from the business of preparing tax returns. As the Chancellor noted in the Budget:

“This will make filling in tax returns dramatically simpler for up to three million firms.”

So in theory cash-based accounting will save small businesses money by simplifying what they have to do, but how beneficial will this change actually be?

The big idea for small businesses

The principle of cash-based accounting is simple: tax is raised on the money which actually passes through your business. With the current accruals system, you pay tax on all work done within the period, regardless of whether an invoice has been issued or the client has paid. This also applies to expenditure, so even if you do not receive your telephone bill for January to March until late April – the next tax year – you still have to include it in the previous tax year’s accounts.

With cash-based accounting everything becomes so much simpler. Your accounts are based on what enters and leaves your bank account during that tax period. You don’t need complex calculations because it’s easy to see the movements of money. If you receive a huge order just before the end of the tax year you won’t need to pay tax on it until you have actually received payment. This again makes things easier for small businesses because you only pay tax on what you actually have, not what you’re going to have in the future.

Cash-based accounting is good news, then?

We certainly hope so! In the current climate small businesses need all the help they can get. Ironically, though, with a system designed to make accounting simpler, the devil may be in the detail.

Simply in terms of the overall principles, a downside to cash-based accounting is it provides a less useful picture of the business’s performance. The actual flow of cash can be erratic – paying bills may be delayed, or payment dates might fall at unusual times, meaning a regular bill might be paid twice in one month and not at all the next. This means it is more difficult to analyse how the business is performing and certain trends or dangers could be masked. For all the simplifications, the movement of money can be chaotic, so the owners of small businesses will have to keep a firm focus on the bigger picture – just as they needed to with the accruals system. It will still be important to monitor cash flow and to keep a weather eye on your key performance indicators.

As with any system change, it is likely to cause some confusion in the transition period and very small businesses are not always well-equipped to deal with this. It’s also true that just as the new system will give, it will also take away. You may not have to pay tax on work done in one tax year which is invoiced in the next, but neither will you be able to claim tax relief.

One of the supposed benefits of the Budget’s new system is it will make ‘creative’ accounting more difficult because cash flow is much easier to pin down. However, the new system may also encourage unhelpful practices, such as delaying payments until the new tax year. It may even hamper the efforts of some entrepreneurs to develop their businesses.

It’s important the credibility of the tax system isn’t undermined by this Budget’s change. Business needs to feel confident about the integrity of taxation, but so long as the Government and HMRC look carefully at the implementation of cash-based accounting there is every reason to hope this new approach will free many very small businesses from a bureaucratic burden.

Now they just need to deal with the mountain of red tape which still remains.

Andy Parker
Chartered Accountant Birmingham

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