What this level covers
In Level 1 you learned why records matter and what HMRC expects you to keep. This level answers the next question: on which date does a sale or a cost count? There are two methods:
- Cash basis: you record income when the money arrives and expenses when you pay them.
- Accruals basis: you record income when you earn it, which is usually the date you invoice, and expenses when you incur them, which is usually the date you are billed. GOV.UK calls this traditional accounting.
This lesson is general information, not accounting or tax advice. Check your own situation with GOV.UK or a qualified accountant.
A simple way to remember it: cash basis follows your bank statement. Accruals basis follows your invoices and bills.
The worked example: Priya's March
Priya is a freelance graphic designer and a sole trader. Here is everything that happened in her business in March:
| Date | What happened | Amount |
|---|---|---|
| 1 Mar | Paid her design software subscription for March | £50 |
| 2 Mar | Paid a stock-photo bill she received in February | £100 |
| 3 Mar | Client paid her for a logo she invoiced in February | £1,200 |
| 10 Mar | Invoiced a client for a website finished in March (paid 15 April) | £2,000 |
| 20 Mar | Invoiced a brand pack (paid 28 March) | £800 |
| 25 Mar | Received a printing bill for March work (she paid it 10 April) | £150 |
DO: Copy this table into a spreadsheet now. You will use it in the task at the end.
Step by step: profit on the cash basis
Only count rows where money actually went into or out of the bank in March.
- Income received in March: £1,200 (February logo, paid 3 Mar) + £800 (brand pack, paid 28 Mar) = £2,000.
- Expenses paid in March: £50 (software) + £100 (February photo bill) = £150.
- Profit = income − expenses: £2,000 − £150 = £1,850.
The £2,000 website invoice is left out because the money did not arrive until April. The £150 printing bill is left out because Priya paid it in April.
GOV.UK gives the same kind of example. If you invoice on 15 March but are paid on 30 April, on the cash basis you record the income on 30 April.
Step by step: profit on the accruals basis
Now count rows by the date the work was invoiced or billed, whether or not money has moved yet.
- Income earned in March: £2,000 (website, invoiced 10 Mar) + £800 (brand pack, invoiced 20 Mar) = £2,800.
- Expenses incurred in March: £50 (software) + £150 (printing bill, billed 25 Mar) = £200.
- Profit: £2,800 − £200 = £2,600.
The £1,200 logo payment and the £100 photo bill are left out because both belong to February. That is when the work was invoiced and the cost was billed.
Why the two figures differ
It is the same business in the same month, but profit is £1,850 on one basis and £2,600 on the other. The difference of £750 comes entirely from timing:
- Income: accruals adds the unpaid £2,000 website invoice and leaves out the £1,200 that belonged to February. That is a net change of +£800.
- Expenses: accruals adds the £150 bill Priya has not yet paid and leaves out the £100 February bill. That is a net change of +£50 in costs.
- Net effect on profit: +£800 − £50 = +£750.
Over a whole business life the totals even out, because every invoice is eventually paid. Within a single month or tax year, though, the two methods can give quite different profits. Keep this in mind:
- Cash basis is simpler and closely matches your bank balance. It never counts income you have not yet received.
- Accruals basis shows what you actually earned in the period. It gives a truer picture of performance, especially when clients pay late.
Who can use each basis
From 6 April 2024, the cash basis became the default for eligible sole traders and for partnerships without corporate partners. Before that date it was only available if turnover was £150,000 or less. That turnover limit no longer applies.
The following must not use the cash basis:
- limited companies
- limited liability partnerships (LLPs)
- partnerships with a corporate partner
- some specialist cases listed by HMRC, such as Lloyd's underwriters and businesses that have ever claimed research and development allowance
A sole trader can choose traditional (accruals) accounting instead. If you do, you say so when you send your Self Assessment tax return. If you run a limited company, such as a cafe set up as a company, your accounts use the accruals basis.
DO: Open the GOV.UK guide "Cash basis" (gov.uk/simpler-income-tax-cash-basis). Read the section "Who must not use cash basis" and confirm whether your business is eligible. Note the date you checked it.
Your task: compare both bases in a spreadsheet
- Use Priya's table, or one real month of your own transactions.
- Add three columns: Invoice/bill date, Money moved date and Amount.
- Add a column marking each row as Income or Expense.
- Total income and expenses where Money moved date falls in the month. This is your cash basis profit.
- Total income and expenses where Invoice/bill date falls in the month. This is your accruals profit.
- Write one sentence explaining the difference, naming the items that cause it.
Key takeaways
- The cash basis records income and expenses when money moves. The accruals (traditional) basis records them when they are invoiced or billed.
- In the same month, the two bases can give different profits. Priya's were £1,850 and £2,600, and the difference is purely timing.
- Since 6 April 2024, cash basis is the default for eligible sole traders and partnerships, with no turnover limit.
- Limited companies, LLPs and partnerships with corporate partners must not use the cash basis.
- Check eligibility on GOV.UK's "Cash basis" guide, in the section "Who must not use cash basis".