What is Cash Basis Accounting?
Cash Basis Accounting is an accounting method in which all the revenues of the company are recognized when there is actual receipt of the cash and all the expenses are recognized when they are actually paid and the method is generally followed by the individuals and the small companies.
This method is generally followed by individuals and small businesses that have no inventory. It is a straightforward method and can be easily tracked. It only considers two types of transactions, i.e., cash inflows and cash outflows. In this method, a single-entry accounting system is followed since, for each transaction, a single transaction record entry is made. Since there is no tally between revenue and expenses in that particular accounting period, so comparisons of previous periods are not possible.
Cash Basis Accounting Example
For example, Ramesh owns a small business for which he has sent out an invoice on Thursday to the customer. But he doesn’t receive the billing amount till Sunday, so the income is recorded against Sunday’s date in the accounting books. So Ramesh does not include the sales done via credit card or from a credit account unless the payment is received in cash.
The following are the principal features –
- It follows a single-entry system (Also, have a look at double entry accounting system)
- Records only cash payments received and cash expenses paid.
- Simple process.
- Not a good accounting tool.
- Lacks build in Error Checking Tool.
- Mainly focuses only on Expenses and does not match Expenses and Revenues.
Where is the Cash Basis of Accounting Used?
It is used in the following cases:
- When a business uses a single- entry system;
- It is used when the business does not sell on its credit, i.e., whenever a customer purchases or a product is sold, payment must be immediately made by cash, check, bank transfer, or third party credit/debit card.
- The business has very few employees.
- When the business owns little (less expensive business supporting physical assets)or no inventory, i.e., the business does not have buildings, massive office furniture, extensive computer database systems, production machinery, etc.
- The company is a sole proprietorship business or privately held and has no bindings to publish income statements, balance sheets, or other financial statements.
Cash Basis Accounting – Small Business
Cash Basis of Accounting Book – Journal Entries
- Since it is a single-entry system and simple, it is easily understood by people with very less or no knowledge and background in finance and accounting.
- No trained bookkeeper or accountant is required to implement and maintain this system.
- It does not require complex accounting software. Hence a business can easily maintain a cash basis single-entry system in a notebook or on a simple spreadsheet.
- Since it tracks cash inflow and outflow, a firm knows how much actual cash it has at a given period.
- Businesses can accelerate payments to reduce their taxable profits, thereby deferring tax liability.
- It gives us less accurate results since the timings of the cash flows do not provide the exact timing of the changes in the financial condition of a business.
- This type of accounting results can be manipulated by not cashing received checks or changing the payment timings for its liabilities.
- This method does not generate accurate financial statements; hence the lenders refuse to lend money to business having cash basis accounting.
- Auditors will not audit or accept financial statements done with this accounting.
- Since the results are often inaccurate, firms cannot publish management reports firms using such accounting.
- This method is unable to give owners and managers important information for the evaluation of the firm’s financial position.
- Since it doesn’t have an error checking system inbuilt, the error goes unnoticeable until the firm receives a bank statement with an unexpected low account balance or an overdrawn account.
Cash Basis Accounting vs. Accrual Basis Accounting
Here we discuss the four differences between Cash vs. Accrual basis accounting
|The simple system that keeps a record of business cash flow;||Complicated method.|
|Apt for small business, sole proprietorship firm that mostly deals with transactions in cash.||Suitable for businesses that don’t get paid right at the moment.|
|Gives a clear picture of the amount of cash in hand and the bank account;||Gives a clear picture of the correct financial position of a business;|
|It doesn’t reflect the money that is owed to you or money you owe to others.||It records money owed to you and the money you owe to others.|
The cash basis of accounting is a way of recording the accounting transactions for revenue and expenses, which are made in cash, i.e., either cash is received, or any payment is made in cash. It is ideal for small businesses. Due to several shortcomings in this particular method of accounting, which we discussed above, companies generally move away from cash basis accounting to an accrual method of accounting after they grow from the initial start-up stage. Finally, whichever method of accounting a company follows (cash or accrual), it is supposed to follow that for both accounting and tax purposes.
Cash Basis Accounting Video
This has been a guide to Cash Basis Accounting. Here we discuss cash accounting examples, features, and its advantages and disadvantages. Here we also present the cash accounting method vs. accrual accounting. You may also have a look at the articles below on accounting –