Artwork for podcast I Hate Numbers: Business Improvement and Performance
Calculating cash profits
Episode 13425th September 2022 • I Hate Numbers: Business Improvement and Performance • I Hate Numbers
00:00:00 00:13:07

Share Episode


Are you a business owner looking to make the switch to cash basis accounting?  The transition can be daunting, but it's worth it if you want to make the most of your profits.  In this podcast I'll take a look at how traditional accounting compares to cash basis accounting and show you how to calculate your tax profits under each system.  Let's get started!

The cash basis for tax seems like the right decision for a lot of small business owners. Moreover, it’s simple, straightforward, and easy to understand. You can use it without having to worry about all of the different rules and regulations that come with using other methods.  However, there are some definite downsides to consider before you make your final decision.

The most important thing is to weigh up the pros and cons carefully so that you can make an informed choice about which method is best for your business. I hope this podcast has helped clear up some of the confusion around calculating profit.  If you have any questions, please don’t hesitate to get in touch.  And don’t forget to subscribe so you never miss an episode!

Using cash profits In order to make your business as successful as possible, it's important to know where you're at financially.  One way to measure this is by you Calculating cash profits.  This involves taking your revenue and subtracting your expenses.  Furthermore, this  gives you a clear picture of how much money is actually coming in and out of your company.  While this can seem like a daunting task, it's a crucial step in making informed decisions about the future of your business.  By understanding your cash profits, you can better assess where you need to make changes and cut costs.  And with that knowledge in hand, you can focus on growing and expanding your business!

Who is eligible to use the cash basis for tax and when it is not suitable

The cash basis for tax is a simplified way of accounting for your business income and expenses. It can be used by most businesses, but there are some cases where it is not suitable. I explore in this podcast post

  • Firstly, who is eligible to use the cash basis for tax
  • Secondly, when it is not appropriate.

Further details can be found here

Calculating tax profits – Traditional accounting versus cash basis

When it comes to calculating profits, there are two main methods, traditional or the cash basis. Each of these methods has its own benefits and drawbacks..


Are you ready to have an easier and more rewarding relationship with your numbers?  My book, I Hate Numbers helps you get there.

This book will show you how to have a rewarding, productive relationship with numbers and your business.  Furthermore, my book will help with that battle between the ears, that all business owners experience.

Grab your FREE cashflow guide Make your own Future Cash Story Plan with Numbers Know How.  Get in touch with us to help make your life easier and stress-free. Contact us if you need help figuring out and sorting your numbers, creating your future financial story plans, your taxpayroll and other accounting and business matters.

Thanks for listening!

This podcast uses the following third-party services for analysis:

Chartable -



Profits? What are they and how do you calculate them? A simple and straightforward way is to look at the money coming into your business. Take away the money going out and by money, I mean cash. Or you can see in your bank statements the notes and coins in your purse or wallet. Now, this method of calculating profit may cause consternation, eye rolls amongst some accounting professionals. It's not the normal way, it's not the traditional way that profits are calculated. However, this approach of calculating cash profits for tax is perfectly fine with our friends at HMRC.


It's also a good starting point for connecting with your numbers. But with all things taxed, there are bound to be rules and conditions. In this week's I Hate Numbers podcast, I'm going to be looking at the two ways of calculating profits, how you can use the cash basis for tax purposes, highlight the conditions and the benefits plus shortcomings of using the cash basis for tax. And also we'll throw some numbers in to help explain what's going on. You may find at the end of this podcast your conclusion is the cash basis is the right one for you. But then again, you may not.


You're listening to the I Hate Numbers podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.


Hi folks. Welcome to another weekly episode on the I Hate Numbers podcast show. My name is Mahmood. I'm an accountant and educator and proud author of the book I Hate Numbers. My mission is to increase the financial awareness amongst business owners, help you and your business make more money, improve your financial understanding, and help you win more battles than you will lose for what goes on between your ears. What's not to love with that? Let's crack on with the podcast. Now, using the cash basis for tax is as simple as it implies.


When we talk about profitability, most business owners, most non-financial, non-accounted business owners will say profit is the difference between what comes in - the cash that you collect minus the cash that goes out. That is also the same approach that HMRC will be adopting for working out cash profits that will enter into your tax return. Now, the two conventional ways, and I'm going to illustrate this with some numbers later on, will be to look at the cash that you collect from your customers, the services you provide, the goods that you sell, and then you take off all the business costs. And those business costs can also include the capital outlay that you've got.


So if you've had to buy machinery, equipment, new plants, mobile phones, computers and the like, the cost of those can be deducted from the cash that you collected. Now that's a simple approach for working out cash profits. And that's exactly the same methodology that HMRC will allow for inclusion in a UK tax return. However, and you know there's going to be however, the traditional way is to ignore the cash completely and to go based on what's called economic activity. Bear with me, folks. So if I sell goods to somebody during the course of a year, if I provide services to somebody for what I've performed during the course of the year, then that monetary value represents my turnover.


It doesn't matter whether my customers are fully paid for those goods and services are provided. If I've done the work, I'm still likely to collect that money, then I include that as my turnover. Likewise, expenses. Expenses are recorded at the moment you have an obligation to pay the supplier, to pay for those goods that you've acquired, to pay for those services you've procured. Doesn't matter whether you physically pay your supply by the end of the year, we still include those as expenses. And lastly, capital costs. Things like buying equipment, buying machinery, we only include what's called depreciation in respect of that asset purchase.


If we're thinking about using the cash basis for tax purposes, first of all we need to understand who is and who isn't allowed to actually use that method. You can use the cash basis if you run a small self employed business, and small, by the way, means with a turnover of £150,000 a year or less, typically it's a sole trader or a partnership that can use that. And bear in mind, folks, if you've got several businesses, then if you choose to use the cash basis for one, then you must use the cash basis for all of them. You can't pick and choose amongst those businesses and the combined turnover from all your businesses must have been more than 150,000. The scheme is not available to the following. Z


So if you happen to be a limited company or an LLP, a limited liability partnership, unfortunately you cannot use the cash basis. It's the traditional route you must go down. If you happen to be a lawyer's underwriter, if you happen to be a security dealer, someone who deals with mineral royalties, a minister of religion, someone who runs a waste disposal company, or a crematorium, or a cemetery, then you cannot use the cash basis. If you check the show notes now, folks, I'll give you a link to give you a more comprehensive list of those who cannot use it. What I want to look at now is the situations where actually using the cash basis, even though it's more straightforward, even though some would argue it's simpler, there are going to be situations where it may not be suitable for your business.


And these are as follows if you have a business and you incur a loss, so the money going out, the cost of running that business, are more than the money coming in. So expenses are greater than turnover, you will have a loss and using losses in a sole trader or a partnership business is more flexible. You may have additional streams of income like from PAYE rental income. Those losses that you make in your business can be offset against those other streams of income if you are not using the cash basis. If you want to carry losses back to a previous year, if you've adopted the cash basis, that loss relief is not available to you. So that could be a major drawback.


If you're looking to raise funding, finance for your business, if you're looking to get a mortgage, it may be that your lender does not like you using cash basis and will prefer to use traditional accounts. If you've borrowed money, if you've got bank charges in excess of £500, then the cash basis will not be suitable for you. Other factors that you've got to consider if you're a business that is a retailer, a manufacturer, you've got large amounts of inventory and it fluctuates, then having a cash business would not be suitable for you. If you've got credit terms you're giving to your customers and you've got to wait a considerable period of time, you may get some benefit from using the cash basis because you're only going to be using and including money you've received. But if you've got one year where the receipts from outstanding customers is peaking and quite high, then that could actually impact on your tax liability in future years.


So fluctuations, volatility in your earning stream could be against you. What I like to do is to move on to now to actually throw some numbers into the pot and let's have a look at some illustrations of the traditional versus the cash route. I want you to imagine a business. Let's assume our business owner is a decorator. During the course of the year, the houses he decorates, the painting and putting up the wallpaper, you understand what I'm saying is to the value of £40,000. The materials that have got to be acquired, the paints, the wallpaper, the turpentine is £10,000 in value and there are additional costs. This decorator has also running their business for the tune of £5000. Let's assume this is their first full year of business. Let's also now add in of the work that's been done for these households, his customers. At the end of his year there's £3000 worth of work that he's carried out for, for which he has not yet been paid.


And as far as the materials which he buys from his local supplier, he's got an outstanding bill to them to the tune of £2000. Let's bundle those numbers together and see what we arrive at. Now if we are using conventional or traditional accounting, the profit would be the £40,000, the value of the work that's been carried out minus the £10,000 for the materials subtract the other running costs of the business, that's 5000 and that gives our trader, our business owner, £25,000 worth of profits.


That's the profits under a traditional conventional approach, and that figure would be used to go into their tax return. Now, if we take into account the invoices that hadn't been paid by the customers or to the suppliers, we then have the following. The turnover under a cash basis with a £40,000 work that's been carried out, minus the £3000 that's not yet been collected by the end of the year. That's £37,000 worth of turnover. The materials, £10,000 is the cost of all the materials acquired. £2000 has not yet been paid to the supplier, so that’s £8000 is the material costs in cash terms. Assume there's no outstanding bill to the other business costs. So therefore, there's a cash profit of 37,000 cash received. Your cash turnover, minus the £8000 paid for the materials, minus the 5000 for the other costs, and that will give us a cash profit of £24,000.


So a lower figure that will go into the tax return. If we then fast forward one more year, let's assume the same level of activity, the same level of costs. Now, in year two, our business owner has done work to the value of 40 and they've actually got £1000 now outstanding from customers at the end of their second year. So in total cash terms, there's the £40,000 worth of work. Add on the £3000 they're collecting from the previous year and then subtract the £1000 that's still owing. That's £42,000 that would flow into the business bank account, that is the cash turnover. Materials £10,000 is the value of the materials they take into account, the 2000 pound that was owing from the last year and there's £1000 worth of bills yet to be paid at the end of the second year.


So in total cash terms, that's £11,000. That's the ten plus the two, minus the 1000 outstanding. Other costs still remain at five. And therefore, in year two, the cash profits are 26,000. Under a traditional, we had £25,000 for each year. Under cash accounting, we had a £24,000 profit in year one and a £26,000 profit in year two. It's also worth concluding, folks, that using a cash accounting methodology, even though it might be simple and straightforward, doesn't actually give us an intuitive, insightful, accurate level of profit.


Now, those words, profit and accuracy may not go hand in hand, but in terms of representing what's going on in the business, the cash accounting approach, even though it's simple, can provide distortions as well. So let's summarise where we are. We've got something called the cash basis. For tax purposes, there are certain conditions imposed on who can use it when it may not be useful. We talked about traditional versus cash accounting in tax terms, a trader can decide which one they wish to use.


You got to be a sole trader or in a partnership, you cannot mix and match. If you've got multiple businesses you take a choice. One methodology applies to all the businesses. Check out the show notes, folks, and there's a table with the numbers that we've talked through in this week's podcast. Folks. I hope you got some value from this podcast. I hope it's been useful. I'd love it if you could subscribe to the channel and share with those that you feel would benefit from it as well. And until next week, folks, take care.


We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.





More from YouTube