Cash Basis Accounting

Article byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Cash Basis Accounting?

Cash Basis Accounting is an accounting method in which all the company’s revenues are recognized when there is actual receipt of the cash, and all the expenses are recognized when they are paid. Individuals and small companies generally follow the method.

Cash-Basis-Accounting

You are free to use this image o your website, templates, etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Cash Basis Accounting (wallstreetmojo.com)

This method is generally followed by individuals and small businesses with no inventory. It is a straightforward method and can be easily tracked. However, 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 periodParticular Accounting PeriodAccounting Period refers to the period in which all financial transactions are recorded and financial statements are prepared. This might be quarterly, semi-annually, or annually, depending on the period for which you want to create the financial statements to be presented to investors so that they can track and compare the company's overall performance.read more, comparisons of previous periods are not possible.

Cash Basis Accounting Explained

The cash basis accounting method 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. Therefore, it is ideal for small businesses. However, companies generally move away from cash basis accounting to an accrual method of accounting after they grow from the initial start-up stage.

Under this method, the accounts payable and receivable are not accounted for because actual cash does not change hands. Thus, revenue and expense is recognized when cash is paid or received irrespective of whether the goods and services have been provided or not. They are suitable for small businesses which do not have a large number of complex transactions to record. It can also be used by individuals who want to record their personal financial transaction for better money management.

It definitely has some disadvantages like it does not show the true financial condition of the business since it does not consider any transaction for which cash will be received in the future. It is also not suitable for inventory management.

Finally, whichever method of accounting a company follows (cash or accrual), it is supposed to follow that for both accounting and tax purposes.

Rules

The following are the principal features of cash basis accounting method

Example

Let us try to understand the cash basis accounting system with an example.

For example, Ramesh owns a small business for which he 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 credit account unless the payment is received in cash.

Form the above example, it can be clearly understood how to do cash basis accounting.

Where Is It Used?

The next question is when to use cash basis accounting and for what kind of entities. It is used in the following cases as mentioned below:

The above points highlight when to use cash basis accounting.

Accounting In Small Business

The below mentioned excel shows how to do cash basis accounting in case of a small business.

Cash Basis Accounting

Journal Entries

Given below are some of the entries that is used while recording the financial cash inflow and outflow for the business using the cash basis. It is to be noted that there is no double entry involved in it where a debit and a credit is recorded in respective books of accounts, as followed in the accrual basis.

Cash Book Balance153.50
Add: Unpresented Check127.00
Subtotal280.50
Less: Deposit (not yet showing)54.00
Bank Statement Balance226.50

Advantages

Disadvantages

Cash Basis Accounting Vs Accrual Basis Accounting

Here we discuss the four differences between Cash vs. Accrual basis accountingAccrual Basis AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more

Cash Basis AccountingAccrual Basis Accounting
The simple system that keeps a record of business cash flowComplicated 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.

Cash Basis Accounting Video

This has been a guide to what is Cash Basis Accounting. We explain its differences with accrual basis accounting, with example, advantages & journal entries. Here we also present the cash accounting method vs. accrual accounting. You may also have a look at the articles below on accounting –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *