What is Cash Accounting?
Cash accounting is a type of accounting that focuses on cash inflow and outflows and therefore considers only the cash received during an accounting period as revenue and cash paid during the same period as expenses and accordinly prepare its Financial Statements.
It is so easy to maintain because one can simply track the expenses and the revenue quickly just by looking at the cash balance. Also, the business doesn’t need to show forth the taxes. Since everything happens in cash, there is no proof of earning, and as a result, the company doesn’t need to pay any taxes until the cash is put into the bank.
Example of Cash Accounting
Let’s say that Company ABC has sold finished products of $200,000 in cash. According to cash accounting, this entry will come under cash revenue since the business is selling its finished products in cash.
But what if Company ABC would sell its finished products of $100,000 in cash and another $100,000 in credit! According to cash basis accounting, only $100,000 would be recorded as cash revenue and not another $100,000, sold on credit. If we look at the accrual basis of accountingAccrual Basis Of AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. , $200,000 would be recorded as the revenue of the company.
Let’s look at another example.
Let’s say that Company MNC has large machinery which has been used for a few years now. Every year, the company assumes depreciation of $4000 on this machinery as wear and tear so that after a few years of use, this machinery can be replaced by a new one.
According to cash basis accounting, this depreciation wouldn’t be counted as expenses. It wouldn’t be recorded because there’s no cash involved in the depreciation expenses and it’s non-cash expenses.
As you can understand, this accounting has few benefits and a few demerits. Let’s first look at the benefits –
- Simple: As a business, you have to choose one of the accounting methodsAccounting MethodsAccounting methods define the set of rules and procedure that an organization must adhere to while recording the business revenue and expenditure. Cash accounting and accrual accounting are the two significant accounting methods.. If you select this accounting, it’s the simplest because you will only record transactions that are related to cash. Other transactions won’t be taken into consideration.
- Maintenance is easy: Maintaining an accrual system of accounting is tough. Compared to that, the maintenance of cash accounting is pretty straightforward. You will record revenue when cash is received from customers, and you will record expenses when cash is paid to suppliers.
- Liquidity: Since it is all about only cash transactions, the potential investors who would like to invest in the business doesn’t need to go through any liquidity ratio. S/he can look at the accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company's performance and ensuring the smooth operation of the firm., look at the cash inflow and cash outflow, and then find out for herself/himself the net cash flow of the business.
- Single-entry accounting: This is single-entry accounting. That means the effect occurs only on one account. It makes things easier for the business, and the business also doesn’t need to follow the matching concept.
There are also a few demerits. Here are they –
- Not very accurate: Since it is only recorded cash transactions and it doesn’t include all the transactions. As a result, we can’t say it is very reliable. Plus, under this accounting revenue or expenses is recorded when the company receives or pays cash, even in the different accounting periods.
- Not recognized by Companies Act: Few businesses follow this accounting, but it is not a recognized method under the Companies Act. As a result, This isn’t practiced by big companies.
- Chances of discrepancies: Since it only records cash transactions, the business can be involved in unfair practices by hiding the revenue or inflating the expenses.
When is Cash Accounting Sufficient?
A big company can’t follow cash basis accounting. But what sort of companies can follow this accounting? In simple terms, when this accounting would be sufficient? Here are a few conditions which need to be fulfilled for this accounting to be adequate –
- When you have a very small business and the business is either sole-proprietorship or partnership.
- When you only need to record a few financial transactions.
- When you have very few employees.
- As a company, you don’t need to record income statementRecord Income StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements., balance sheets, or any other financial statements.
- As a company, you never do business with credit. Every transaction (most of it) is in cash.
- You also have very limited fixed capitalFixed CapitalFixed capital refers to the investment made by the business for acquiring long term assets. These long term assets don’t directly produce anything but help the company with long-term benefits..
Cash Accounting Video
This has been a guide to what is Cash Accounting, their examples, advantages, and disadvantages, etc. You may also have a look at these accounting articles to enhance your knowledge