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 which was sold on credit. If we look at the accrual basis of accounting, $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 and wouldn’t be recorded because there’s no cash involved in the depreciation expenses and it’s totally non-cash expenses.
As you can understand this accounting has few benefits and few demerits. Let’s first look at the benefits –
- Simple: As a business, you have to choose one of the accounting methods. If you choose 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 maintenance of cash accounting is pretty easy. 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 system, 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 accurate. 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 sufficient –
- 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 statement, balance sheet 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 capital.
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
- Top 2 Types of Accounting Methods
- Purpose of Cost Accounting
- Definition of Financial Accounting
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- Financial Accounting vs Management Accounting (Top Differences)
- Debit vs Credit in Accounting | Top Differences You Must Know!
- Cost Accounting vs Management Accounting | Top Differences