What Is Cash-Based Accounting?

As the name suggests, the underlying factor in cash based accounting is cash itself. Transactions are recorded whenever you receive cash payments from customers, or whenever cash leaves your company in the form of expenses or vendor payments.

Let’s look at an example that illustrates this method with a sales and a purchase transaction;

Sales transaction:

Suppose you’re a carpet retailer, and you sell carpets worth $100 to a client on the 1st of July, and your client makes a cash payment on the 5th of July.

In cash accounting, you record the sales transaction on the 5th of July (when you receive the cash).

Purchase transaction:

You buy carpets from your vendor for $100 on the 10th of June. For this purchase, you make cash payment only on the 6th of July.

Here, you record the purchase transaction on the 6th of July (when you pay cash).

The Pros And Cons Of Cash Accounting;

Pros

• Cash accounting is simple offers many advantages to very small businesses that operate purely on a cash basis.
• It doesn’t require you to have vast accounting knowledge and its simplicity allows you to maintain your accounts without having to hire an accountant.
• It also doesn’t require accounting software, because you can accomplish accounting tasks with a simple cash book, or with spreadsheet software.
• The most important advantage of this method is that it records your transactions purely in terms of cash inflows and outflows. This provides an accurate picture of how much money there is in your company at any given time.

Cons

• Although it’s simple to implement and provides accurate insights about your cash flow, cash accounting has a few downsides.
• Companies that account on the basis of cash don’t usually employ an integrated accounting system. This can increase the chance of errors, as there is no built-in error-checking mechanism.
• While it shows you how much money you have, it doesn’t show you your financial position. This is because cash accounting doesn’t make it easy to generate reports like income statements and balance sheets that are necessary to determine your financial position accurately.

When Do You Use Cash Accounting?

Cash-based accounting is usually used by very small businesses. You might follow the cash basis of accounting if:

• Your business is very small, held by sole proprietorship or privately.
• You do not sell on credit, i.e., you do not provide goods without immediate payment and invoice customers later.
• You use a single-entry accounting system.
• You have only a few employees working in your company, and a cash accounting setup is enough to handle employee salaries and reimbursements.
• You have relatively few transactions each day and they can be recorded in a cash book or a spreadsheet.
• You do not own many physical assets and tracking inventory for them isn’t necessary.

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