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.

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 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.

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Features

The following are the principal features –

  • It follows a single-entry system (Also, have a look at double entry accounting systemDouble Entry Accounting SystemDouble Entry Accounting System is an accounting approach which states that each & every business transaction is recorded in at least 2 accounts, i.e., a Debit & a Credit. Furthermore, the number of transactions entered as the debits must be equivalent to that of the credits. read more)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 sheetsBalance SheetsA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more, or other financial statements.

Cash Basis Accounting – Small Business

Cash Basis of Accounting Book – Journal Entries

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 accountantBookkeeper Or AccountantA bookkeeper is responsible for performing the bookkeeping activities where financial transactions are recorded systematically. In contrast, accountants are responsible for accounting financial transactions that have occurred in the past and reporting financial affairs showing the clear financial position of the company.read more 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 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

  • It gives us less accurate results since the timings of the cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more do not provide the exact timing of the changes in the financial condition of a business.This type of accountingType Of AccountingThere are different types of the accounting which an organization can follow as per the scope of its work and need of stakeholders. Some of them include financial accounting, forensic accounting, accounting information system, managerial accounting, taxation, auditing, cost accounting, etc.read more 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 statementsFinancial StatementsFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more done with this accounting.Since the results are often inaccurate, firms cannot publish management reports using such accounting.This method cannot 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 balanceAccount BalanceAccount Balance is the amount of money in a person’s financial account, such as a savings or checking account, at any given time. Furthermore, it can refer to the total amount of money owed to a third party, such as a utility company, credit card company, mortgage banker, or other similar lender or creditor.read more or an overdrawn account.

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

Conclusion

The cash basis of accounting is a way of recording the accounting transactionsAccounting TransactionsAccounting Transactions are business activities which have a direct monetary effect on the finances of a Company. For example, Apple representing nearly $200 billion in cash & cash equivalents in its balance sheet is an accounting transaction. read more 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, 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 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 –

  • Accounting Transactions ExamplesCash AccountingCash Accounting vs Accrual AccountingExamples of the Accounting Equation