Cash Basis Accounting

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 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, 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.

Cash Basis Accounting

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For eg:
Source: Cash Basis Accounting (wallstreetmojo.com)

Features

The following are the principal features –

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 Accounting

Cash Basis of Accounting Book – Journal Entries

Bank Reconciliation

Advantages

  • 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.

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

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.

Conclusion

The cash basis of accounting is a way of recording the accounting transactionsAccounting TransactionsAn Accounting Transaction is a business activity or transaction that has a monetary impact on a company's financial statements. It is based on the generic equation: Asset = Liabilities + Equity. Internal accounting transactions and external accounting transactions are its two types.read more 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 –

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