Bookkeeping - at least in terms of the HMRC requirements - doesn’t require that you hire an accountant or use bookkeeping software. As long as you can accurately state your income and expenses on your tax forms (and you’ve got the records necessary to prove that you’re correct), you’ve satisfied HMRC.
HMRC doesn’t require all businesses to use a prescribed accounting method, but it does require businesses to use a system that accurately reflects their income and expenses.
The two common ways to account for your income and expenses are the cash method and the accrual method (and some businesses use a hybrid). What do most small business owners prefer? According to a 2006 survey, 41% use the cash method, 17% used accrual, 13% used a hybrid, and a surprising 28% did not know what system they used (attributed to the fact that these owners did not have a “hands-on approach” to record keeping).
The cash method
Using the cash method, you record income when you actually receive it and expenses when you actually pay them. For example, if you paid to list your business in a UK business directory in December 2008 but don’t get paid until March 2009, you record the income in March 2009. Similarly, if you buy a digital camera for your business on credit, you record the expense not when you charge the camera and take it home, but when you pay the bill. (HMRC won’t let you manipulate your income by, for example, not cashing a client’s check until the next year; you must report income when it becomes available to you, not when you actually decide to deal with it.)
The accrual method
Under the accrual method, you record income as you earn it and expenses as you incur them. For example, if you complete a project in December 2008, that’s when you record the income you expect to receive from the project, no matter when the client actually gets around to paying you. (If the client never puts the check in the mail, you can eventually deduct the money as a bad debt.) And if you charge some furniture, you record the expense on the day of purchase, not when you pay the bill.
Which method is better?
The cash method is much easier to use; most of us deal with our personal finances this way, so it’s a system we’re familiar with. It also gives you a clear picture of your actual cash on hand at any point in time. The accrual method can’t tell you how much cash you’ve got, but it provides a more accurate picture of your business’s overall financial health, particularly if your clients or customers are pretty good about paying their bills. It will show money that you’ve obligated yourself to pay, so you’ll know that you can’t count on using that money for other purposes. It will also show money you can look forward to receiving (again, if your customers pay you as promised).