27 Jul 2012 02:59pm

Coining it

Announcements in March’s Budget that small businesses with turnovers of up to £77,000 – ultimately £150,000 – per year could be allowed to shift their accounting to a cash-based system, show that the government is keen to present a business-friendly face

But the jury is out on whether these measures will genuinely simplify accounting and tax arrangements for the three million or so businesses that would qualify. And with IFRS for SMEs also on the horizon (see box, right), some commentators argue that micro-businesses as well as enterprises with growth aspirations will be left as hard-pressed as ever on the regulatory front.

The proposals to allow smaller businesses – the UK’s army of sole traders among them – to account on a cash basis came originally from the Treasury’s Office of Tax Simplification (OTS). In February the OTS recommended that cash accounting plus a range of fixed-rate deductions be accepted for small businesses. The OTS believed it was targeting businesses that use and understand cash accounting and that aligning tax and accounting regulations with common practice would bring greater clarity and reduced cost and red tape.

Cash accounting takes growth businesses away from the basic structure of the profit and loss account… you're not getting used to business language

Clive Lewis

The OTS, however, was focusing on businesses with a turnover of up to £30,000. At some point between late February and Budget day, the Chancellor decided to target a wider group.

Opinion divided

At the time of writing, the Budget proposals were out for consultation and opinion divided over what form they will take. Ed Molyneux, CEO and co-founder of online accountancy service FreeAgent, a partner with software firm IRIS, says the moving limits on company turnover size may not be as bewildering as they first appear. "Some companies start small and get bigger but the vast majority stay where they are," he says.

He believes more complex companies need more information on how a business is performing, whether a particular customer is profitable or not.

"But for hobby or sideline businesses cash accounting may well be appropriate," he says. "Setting the limit at the VAT threshold seems sensible, but may have the effect of complicating matters for moderate-scale businesses with turnovers fluctuating around that level. So £150,000 does make sense as an exit point – if you reach that figure, you are well on your way as a business."

Clive Lewis, ICAEW’s head of enterprise, argues that the government should set a threshold of £30,000 for a test period to allow it to evaluate any negative consequences. Cash-based accounting undoubtedly simplifies administration for small and micro businesses and removing complication may save money and time for some, he argues. But he is concerned that the measures will do growth businesses no favours.

"Cash accounting takes them away from the basic structure of the profit and loss account," he says. "You lose the need for figures such as turnover, gross margin, operating expenses and net profit. The sooner business owners get familiar with those concepts the better business managers they will be."

Accounts with any level of complexity tend to be prepared through software, Lewis adds, which can take the sting out of converting a cash book into a set of full accounts. While accruals accounting is a steeper learning curve for business owners without a finance background, it does give them a passport to discussing their business with others. "If you’re using a cash-based system you’re not getting used to the business language," Lewis says.

Richard Churchill, partner with central London firm Shelley Stock Hutter, agrees. His five-partner firm deals with many start-up businesses. Although setting up an accruals-based system will initially be more challenging, constructing accounts in a spreadsheet or in a cash book is a false economy and presents a misleading picture on future funding needs, he says. "You may well make bad decisions based on cash accounting."

He urges a more complete and forward-looking view of finances. "You can’t get a true picture by looking at what is going in and out of the bank," says Churchill. "The worst thing would be to take money out for a dividend or pay award when in reality you will need that money for something else. You need to be forecasting forward. It may be more time-consuming initially and a bit more costly, but it gives greater hope of success."

He recalls one start-up, an event management company, which took the trouble to install an accruals-based system. The software flagged a requirement for £50,000 of future investment six months down the line, giving the founders time to approach their investors for a further £10,000 each. Cash accounting can also lead to a lack of discipline on both creditor and debtor management, Churchill argues. It is too easy to focus on the customers that are paying you and fail to chase up late payers.

On the supplier side, too, not attending to payment terms can mean new businesses fail to build up strong relationships with the companies they will need if they want to grow quickly. "Building up goodwill is very important for growth businesses. Just paying ad hoc when you have money in the bank won’t do that," he says.

Taxing concerns

Anita Monteith, ICAEW’s technical manager for SME tax, says the table of fixed rate deductions that accompanies the cash accounting proposals could amount to massive administrative savings for small businesses, although the principle is more attractive than the amounts proposed at the time of writing.

She believes that unless the amounts are increased, small businesses will be better off claiming a deduction for a proportion of their actual costs to cover home phone, internet and car use.

There are also concerns that the proposals may lead to obfuscation on the tax front. "With cash accounting, it may be relatively easy to distort figures to your advantage – to make a big payment at the end of the year, for instance, to bring tax relief forward," says Lewis.

Simon Witkiss, product director at IRIS Accountancy Solutions, says businesses can and do use cash accounting for VAT calculation up to the millions. "However, for cash accounting to be a success HMRC must resist the temptation to implement too many rules around minimising tax avoidance," he says.

"The increased limit the chancellor has proposed probably increases the pressure on HMRC to strike the right balance between simplicity and fairness. Businesses will also need to understand that while their accounting may be simplified that doesn’t mean the tax rules on what is an allowable expense are lessened."

Monteith is concerned that in the name of simplification we will end up with a more complex set of options, with businesses checking to see which ones leave them better off. Rules will be needed around when and how businesses can or should enter or leave the scheme and also around the principles of cash accounting itself – what do we mean by cash? When can a business consider it has made a payment?

"The way the rules look at the moment there may not be much real simplification involved," she says.

And for businesses with true growth potential, the rules might have the effect of limiting their ambition. "Once you apply a distinction people trade up to that level and not beyond."


In light of the complexities of the initiative to arrive at IFRS, UK SMEs might view IFRS-based UK GAAP with trepidation.

Given that the original aim, in part, was to minimise financial crises through distortion within company results, some wonder if we have been overtaken by events.

But John Boulton, corporate reporting manager in ICAEW’s financial reporting faculty, says IFRS for SMEs has been refined to make them palatable to UK constituents. The standards are, he says, more concise than current UK GAAP and give more up-to-date reporting.

Aspects of the IFRS for SMEs made the regime unsuitable for the UK unmodified, but the new UK standards based on it have been enhanced through consultation.

The new standards address concerns whether businesses will be able to:

  • Revalue property, plant and equipment
  • Capitalise development costs (an issue for tech companies with small turnover)
  • Capitalise borrowing costs.

These options are reinstated under the proposed new UK GAAP. In addition the UK GAAP will require certain financial instruments – foreign exchange forwards or commodities forwards used by agri-businesses – to be recognised on the balance sheet.


Liz Loxton