Which accounting method should I use?
Before you start bookkeeping for your business, you’ll need to decide which type of accounting you will be doing. Cash and accrual accounting are two different methods, both with pros and cons. Here’s a quick explanation of the differences between the two.
With cash accounting, you record transactions when you get cash or pay an expense. Cash accounting is an easy to use method and has the benefit of allowing you to track cash flow. The downside is that, as there are no accounts receivable or accounts payable, it could make finances look healthier than they are. VAT is paid or reclaimed to or from HMRC based on the date invoices were paid. Cash accounting is only available for sole traders with a turnover of £150,000. This can be useful as it means that it will delay the tax that you need to pay for self assessment as you do not have to pay tax on invoices that were unpaid at the year end.
If you are not eligible for cash accounting, you can use accrual accounting alongside cash VAT. If you are a limited company or a sole trader with a turnover of £1.35 million or less you have the option to use cash VAT. Cash VAT is effectively means that although your accounting has to be done on an accrual basis for the purposes income tax, your VAT return can be prepared using the cash accounting method.
Accrual accounting (or invoice basis) is a more common way of bookkeeping than a cash method. Revenue and expenses are recorded before money is paid, for example when the invoice is sent or received. Accrual accounting looks at what a business is worth from a long term point of view as it includes accounts receivable and accounts payable. Be aware that it doesn’t give a picture of cash flow, so this is something to monitor yourself. You pay or reclaim VAT to or from HMRC based on invoice date.