Cash Basis Accounting for Sole Traders Explained
Cash basis accounting is now the default way UK sole traders work out their taxable profit. You count money when it actually arrives or leaves, not when you send an invoice or receive a bill. This explainer covers how the cash basis works, what changed in 2024, when traditional accounting might suit you better and the mistakes to avoid. It is general information, not tax advice, so check GOV.UK or an accountant if your situation is not simple.
Key takeaways
- Under the cash basis, you record income when money comes in and expenses when money goes out.
- Since 6 April 2024, the cash basis is the default for sole traders and partnerships without corporate partners.
- You can opt out and use traditional (accruals) accounting, which can suit businesses with lots of stock or that need full accounts for finance.
- Limited companies cannot use the cash basis.
- Unpaid invoices at the end of the tax year are not taxed until they are paid, which helps cash flow but can shift profit between years.
If you are a freelancer or sole trader, you probably already think in cash terms. You know when a client pays you, and you know when money leaves your account. The cash basis simply turns that instinct into the official method for calculating your profit for Self Assessment.
The alternative, traditional or accruals accounting, matches income and expenses to the period they relate to, regardless of when money moves. It is more accurate as a picture of performance, but it takes more work. For most one-person businesses, the cash basis is simpler and perfectly adequate.
How the cash basis works
The principle is straightforward. Each tax year runs from 6 April to 5 April. Your taxable profit for that year is, broadly, the business income you received in the year minus the allowable expenses you paid in the year.
- Income counts on the date the money reaches you, whether by bank transfer, card payment, cash or a payment platform.
- Expenses count on the date you pay them, not the date on the supplier's invoice.
- Invoices you have sent but not been paid for are not yet income.
- Bills you have received but not paid are not yet expenses.
Example
Imagine a web designer who finishes a project in March and invoices the client £3,000 on 28 March. The client pays on 20 April. Under the cash basis, that £3,000 is income in the tax year that started on 6 April, because that is when the money arrived. Under traditional accounting, it would usually count in the earlier year, when the work was done and invoiced. The figures are invented for illustration.
This is why the cash basis can be kind to cash flow: you do not pay tax on money you have not yet received. If a client never pays, you never count it as income, so there is no need to claim relief for a bad debt.
What changed in April 2024
Before April 2024, the cash basis was optional and had an entry limit based on turnover, so larger businesses had to use traditional accounting. From the 2024/25 tax year, the rules flipped.
The changes also relaxed several earlier restrictions that used to make the cash basis less attractive for some businesses. The practical effect is that many more sole traders now use the cash basis automatically, often without realizing it, unless they choose to opt out.
Pro tip
If you have used traditional accounting in past years and are now on the cash basis by default, or are switching the other way, there can be adjustments in the year of change so that income or expenses are not counted twice or missed. Ask an accountant to check the transition year.
Who can and cannot use it
| Business type | Cash basis? |
|---|---|
| Sole trader | Yes, it is the default |
| Partnership where all partners are individuals | Yes, it is the default |
| Partnership with a company as a partner | No |
| Limited company | No, companies use traditional accounting |
| Limited liability partnership | Check GOV.UK, as different rules can apply |
Property income for landlords has its own cash basis rules, which sit outside this guide. If you have both a trade and rental income, check the guidance for each separately.
Cash basis or traditional accounting?
You can choose traditional accounting instead. The decision is about simplicity versus a more accurate match of income and costs to the period they relate to.
Cash basis suits you if
- You sell services and hold little or no stock
- You want the simplest possible bookkeeping
- Clients sometimes pay late, and you prefer not to pay tax before you are paid
- You rarely buy large assets other than cars
Traditional may suit you if
- You hold significant stock or work in progress
- You need full accounts for a loan, mortgage or investor
- Your income is very lumpy across year ends
- You want accounts that show true performance each period
Businesses that buy stock in bulk are the classic case for traditional accounting. Under the cash basis, a large stock purchase just before the year end becomes an expense immediately, which can create a loss in one year and an unusually high profit the next. Traditional accounting carries unsold stock forward, so profit is smoother.
If you apply for a mortgage or business finance, lenders usually ask for SA302 tax calculations and tax year overviews from your HMRC online account, or accounts, often for two years. Requirements vary by lender, so if you expect to need finance, ask whether they have any preference about how your accounts are prepared.
Keeping cash basis records
The cash basis does not mean fewer records. HMRC still expects you to keep evidence for every figure on your return. It just makes the dates easier: you follow your bank statements.
- Use a separate account for the business. It is not legally required for sole traders, but it makes the bank statement your income and expense list.
- Record the payment date, not the invoice date. Most bookkeeping software does this automatically when it imports bank transactions.
- Track unpaid invoices separately. They do not count as income yet, but you still need to chase them, and you need to know what you are owed.
- Keep receipts and invoices. The bank line shows money moved, the receipt shows what it was for.
- Handle cars through capital allowances or the mileage rate. Most equipment is just an expense under the cash basis, but cars are an exception.
If you are within Making Tax Digital for Income Tax, your software keeps digital records and sends quarterly updates. The cash basis works well with that, because updates simply reflect money received and paid in each period.
Common cash basis pitfalls
Ignoring year-end timing
Because dates matter, a payment received on 5 April and one received on 6 April fall in different tax years. That is fine, but it means your profit can swing based on when clients pay. Plan your tax savings with that in mind.
Forgetting money owed to you
Unpaid invoices are not income for tax, but they are still yours. Some freelancers lose track of them because they do not appear in their profit figure. Keep an aged list of what you are owed.
Treating loans as income
Money you borrow, or money you pay into the business from savings, is not business income. Likewise, loan repayments are not expenses, though interest can be, within the rules. Label these transactions carefully.
Common mistake
Assuming the cash basis means you can claim anything you pay for. The usual rules still apply: costs must be incurred wholly and exclusively for the business, personal or mixed-use items are claimed only for their business share, and entertaining clients is not allowable.
Cash basis action plan
- Confirm which accounting method you used last year and which you will use this year
- Check your bookkeeping software is set to record by payment date
- Keep a running list of unpaid invoices and chase overdue ones
- Label loans, transfers and owner funds so they are not counted as income or expenses
- Decide whether stock or finance plans make traditional accounting a better fit
- Ask an accountant to review any year in which you switch methods
Frequently asked questions
Do I need to tell HMRC I am using the cash basis?
For most sole traders, the cash basis now applies automatically. If you want to use traditional accounting instead, you opt out through your Self Assessment return. Check the latest guidance on GOV.UK for how to make the choice.
Can I switch back and forth each year?
You can change methods, but switching can create adjustments to make sure nothing is taxed twice or missed. Most businesses pick a method and stick with it unless their circumstances change. Get advice before switching.
Does the cash basis change how much tax I pay overall?
Over the life of a business, total profit is broadly similar under either method. The difference is mainly timing: which tax year income and expenses fall into. Timing can still affect your bill because of how tax bands and allowances apply each year.
Is the cash basis the same as cash accounting for VAT?
No. The VAT cash accounting scheme is a separate VAT scheme with its own rules. You can use the cash basis for Income Tax whether or not you are registered for VAT.
Related reading
The bottom line
For most UK sole traders, the cash basis is the simplest way to work out profit: count money when it comes in and goes out, keep the evidence and you are largely done. Consider traditional accounting if you hold a lot of stock, need full accounts for finance or want a smoother picture of performance.
This is general information rather than tax advice. Rules can change each tax year, so check the latest guidance on GOV.UK or with HMRC, and ask an accountant if you are switching methods or unsure which suits you.
