For many companies, tax season means stress. Not only do tax returns have to be filled out and sent in on time, but the HMRC also needs an accurate overview of all of your company’s operating income and expenses in order to determine the amount of your tax payment. Small companies, self-employed in­di­vidu­als, and freel­an­cers can all use cash-basis ac­count­ing for this. The prin­ciples of cash inflow and outflow are described here. But what exactly do those prin­ciples mean, and how spe­cific­ally are they applied?

Fact

Small busi­nesses are generally free to choose between cash-basis ac­count­ing and accrual method of ac­count­ing. However, busi­nesses with over £150,000 in turnover per year are required by the HMRC to use accrual ac­count­ing. This includes the turnover from all of your busi­nesses, in case you run more than one - in which case, you also must use cash basis for all busi­nesses. Companies too big for cash-basis ac­count­ing are en­cour­aged to use double-entry ac­count­ing to help keep track of their finances. If your business grows to a turnover of up to £300,000 during the tax year, you can keep using cash basis, but must switch to a tra­di­tion­al method for the next year.

What does cash inflow and outflow mean?

Cash inflow and outflow play a decisive role in cash-basis ac­count­ing. To be able to submit your annual income to the HMRC properly, you need to record all company revenues and ex­pendit­ures, and offset them against one another. This just means citing what your company has taken in and spent during the fiscal year. So, for this form of profit cal­cu­la­tion, only the actual cash flow is taken into account. But what does that actually mean?

The revenues (inflow) and ex­pendit­ures (outflow) are the sums that directly enter or exit the account. ‘Float’ amounts, i.e. money floating in the system between the two ends of a trans­ac­tion (before being deposited in the recipient’s account or being deducted from the sender’s account), are not counted here. Just look at the sums that have been entered or taken out of your account at which time. This approach is the basis of the cash inflow and outflow principle.

Summary

The timing of the cash flow is the main aspect of the cash inflow and outflow principle. Which op­er­a­tion­al incomes and ex­pendit­ures count toward the tax year and which don’t is decided by the date of the payment deposit or deduction.

Cash inflow principle

According to the HMRC, cash flow in the method of cash-basis ac­count­ing must record income in the tax year when the payment was received, re­gard­less of when it was actually recorded in your books. An example of the cash inflow principle would be as follows: You’re a fiscal year tax payer and have adopted your fiscal calendar to start in July of each year. You receive a payment on June 30, 2017 but you don’t enter it into your books until July 1, 2017, the start of the new fiscal year. While it can remain in the new fiscal year in your books (fiscal year 2018), it must be processed for tax reasons in the gross income for fiscal year 2017 – the year in which the payment was actually received.

Tip

Remember that credit card payments and transfers also count the actual date of the debit.

One point of interest is that the cash inflow doesn’t only decide the amount of your income, but also in­flu­ences your tax bracket and how much you pay – the higher your income, the higher your bracket.

Tip

It’s worth­while to record larger amounts of money at the end of the year for the following fiscal year. This allows you to keep your current profit margin low and pay fewer taxes.

Cash outflow principle

The cash outflow principle also uses the timing as a deciding factor for your profit cal­cu­la­tion. Basically, it works just like cash inflow, but the timing of the actual payment is the decisive factor here. Expenses paid in advance are either counted toward the year in which they are applied, which can po­ten­tially split cash outflow across multiple tax years. Because payment date is so crucial for tracking cash outflow, it’s very important to keep all invoices and records of payment.

Tip

You can avoid most problems with VAT by making sure you deal with all the paperwork correctly. You may have to submit invoices and other documents to the HMRC. Make sure that you’re able to provide proper and complete ac­count­ing documents.

When it comes to cash outflow, there’s a special exception: de­pre­ci­ation, or the wear and tear of an asset (e.g. machines), may not be taxed for the full sum within one calendar year. The costs are instead dis­trib­uted over several years, according to the uniform cap­it­al­iz­a­tion rules.

Please note the legal dis­claim­er relating to this article.

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