But cash basis accounting and traditional accounting can produce different profit figures in the same year. Understanding why helps you make sense of your tax return, your business performance and what the numbers are actually telling you.

We use a straightforward decorator example to show how the same business activity can produce a £25,000 traditional accounting profit but a £24,000 cash profit in one year, before the timing difference reverses in the following year.

About this episode

Cash basis accounting focuses on when money actually moves. Income is recorded when we receive it and allowable expenses when we pay them.

Traditional accounting takes a different approach. It looks at the economic activity of the business, so income and expenses can be recorded even when the corresponding cash has not yet been received or paid.

Neither idea should be confused with simply looking at the balance in your bank account. There are still tax rules around what counts as business income and what expenses are allowable.

If you want the wider foundation first, our guide to What Is Profit? Gross Profit and Net Profit Explained looks at what profit means and why it matters to your business.

Cash basis versus traditional accounting

How cash basis accounting works

Under cash basis accounting, we record business income when the money is actually received and allowable expenses when they are actually paid.

So if a customer owes you money at the end of the tax year but has not yet paid you, that amount is not normally included as cash-basis income for that year. In the same way, an unpaid supplier bill has not yet become a cash-basis expense.

This makes the basic calculation easy to understand:

Cash received – allowable business expenses paid = cash-basis profit

For many items of business equipment, the amount paid can generally be treated as an allowable expense under the cash basis. Cars have different rules.

How traditional accounting works

Traditional accounting, also known as accruals accounting, is based more closely on when the business activity happens.

If you have completed work and invoiced a customer, that income can form part of your turnover even if the customer has not paid you by the end of the period.

Likewise, business expenses can be recorded when the obligation arises rather than waiting for the cash payment to leave your bank account.

This can give a different view of profit because it connects income and costs more closely to the activity that generated them.

Current UK cash basis rules

Cash basis rules have changed since this episode was originally recorded in 2022.

From 6 April 2024, cash basis became the default method for eligible sole traders and partnerships without corporate partners. You can choose to use traditional accounting instead.

The previous £150,000 entry threshold no longer applies. The old £500 restriction on interest deductions and the specific cash-basis restrictions on loss relief were also removed. If you have more than one business, you can now choose cash basis or traditional accounting separately for each one.

Limited companies, limited liability partnerships and partnerships with corporate partners cannot use the cash basis for this purpose.

You can check the latest eligibility and exclusions in the current GOV.UK cash basis guidance.

When traditional accounting may still be useful

Simple does not automatically mean suitable for every business.

Traditional accounting may give you a clearer picture where your business has significant stock, customers who take a long time to pay, substantial amounts owed to suppliers, or where a lender wants accounts showing what the business is owed and what it owes.

Cash receipts can also move sharply between periods. That means cash-basis profit can fluctuate because of payment timing even where the underlying level of business activity has not changed very much.

Calculating cash profits: a simple example

Imagine a decorator who carries out £40,000 worth of work during the year.

Work carried out: £40,000
Materials used: £10,000
Other running costs: £5,000
Customer invoices still unpaid at year end: £3,000
Material bills still unpaid at year end: £2,000

Traditional accounting profit

Traditional accounting looks at the £40,000 worth of work carried out, regardless of whether every customer has paid by year end.

£40,000 turnover – £10,000 materials – £5,000 other costs = £25,000 profit

Cash profit in year one

The cash calculation is different because £3,000 of customer invoices has not yet been received.

Cash received is therefore £37,000.

Of the £10,000 materials cost, £2,000 has not yet been paid, so the cash paid for materials is £8,000.

£37,000 cash received – £8,000 materials paid – £5,000 other costs = £24,000 cash profit

We therefore have £25,000 of profit under traditional accounting and £24,000 under the cash basis.

What happens in year two?

Now imagine the underlying level of work and costs stays the same, but some of those outstanding amounts are collected and paid in the following year.

In the example from the episode, cash received becomes £42,000, material payments become £11,000 and other running costs remain £5,000.

£42,000 – £11,000 – £5,000 = £26,000 cash profit

Traditional accounting still produces £25,000 of profit.

Across the two years, the traditional profits are £25,000 and £25,000. Cash profits are £24,000 and £26,000. The overall £50,000 is the same, but the timing is different.

Cash basis can be simple and straightforward, but payment timing can change the picture you see from one year to the next.

FAQs

What are cash profits?

Cash profits are broadly based on business income actually received minus allowable business expenses actually paid during the period.

Is cash basis now the standard method for self-employed businesses?

For eligible sole traders and partnerships without corporate partners, cash basis became the default method from 6 April 2024. You can choose traditional accounting instead.

Can a limited company use cash basis accounting for its taxable profit?

No. Limited companies and limited liability partnerships are excluded from this Income Tax cash basis.

What happens to an unpaid customer invoice under cash basis?

Cash basis normally records the income when you actually receive the money, rather than when you issue the invoice.

Is cash basis always better because it is simpler?

No. Simplicity is useful, but the timing of receipts and payments can make cash-basis profit fluctuate. Traditional accounting can sometimes give a more useful view of the underlying activity and financial position of the business.

Episode Timecodes

00:00 – What cash profits are and why cash basis matters
02:17 – How the cash basis calculation works
03:45 – How traditional accounting records income and expenses
04:24 – Eligibility for cash basis as discussed in the original episode
05:59 – Situations where cash basis may not suit a business
07:36 – Introducing the decorator example
09:09 – Calculating traditional profit and year-one cash profit
10:09 – Year-two cash profit and the effect of timing differences

Note: the eligibility rules discussed in the original 2022 audio have changed. The written guidance above reflects the current cash basis position.

Related episodes

Key takeaway

Cash basis and traditional accounting are different ways of deciding when business income and expenses enter your profit calculation.

Cash basis follows money received and money paid. Traditional accounting follows the underlying business activity more closely. That difference can change the profit reported in an individual year even when the longer-term economics of the business are unchanged.

The right approach is not simply about choosing the easiest calculation. It is about understanding what your numbers mean, how the tax rules apply and whether the method gives you the information you need to run your business well.

Further Support

The I Hate Numbers podcast helps business owners understand profit, tax, cash flow, bookkeeping, planning and business decisions in a practical way. We simplify business finance so you can make better decisions and feel more confident with your numbers.

If you need help understanding your taxable profit, choosing an appropriate accounting approach or making sense of your business numbers, you can contact us for an initial chat.

You can also use our free online business calculators to support your profit and tax planning, or grab our FREE cashflow guide to help you plan ahead.

For more practical finance and tax support, visit the I Hate Numbers YouTube channel, or listen and follow on Apple Podcasts.

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Cash Profits Explained: Cash Basis, Traditional Accounting and Tax