Two accounting methods are used to record transactions regardless of cash or cash in hand. We saw how transactions are recorded in the accrual accounting method though we didn’t have cash in hand. But on a Cash basis accounting method, we record transactions as income or expense only when we have cash in hand.
Also read: 7 Differences Explained on Cash Basis vs Accrual Basis
What is Cash Basis Accounting? Definition
A cash basis of accounting is one of the two accounting methods that records income and expenses only when the cash is received.
This is not the same with the Accrual basis. On an accrual basis, the transaction is recorded as income or expense when the transaction is initiated, though you don’t have the cash in hand.
Let me make it more clear with an example,
Suppose I manufacture toys and a wholesaler wants to buy 1000 pieces from my firm, and also today is the last date of the current financial year. If the wholesaler pays me 1000 pieces today, I record this transaction in the current financial year. If he/she pays me tomorrow, then the transaction is accounted for in the next financial year. On a cash basis, the transaction is noted only when the money is received.
When Should You Use Cash Basis Accounting?
Cash basis and Accrual basis are two types of accounting; though cash basis is easy because you account for the transaction only when the money is received, it is not accurate and can create a fuss. On the other hand, the accrual basis of accounting helps you accurately record the income and expenses for the financial year.
This method of accounting is useful because
- It is easy to implement
- Easily understandable
- Single-Entry System
- Shows the cash flow
But the IRS restricts businesses from using the “Cash Basis” because it is a short-term measurement and does not reflect the company’s exact financial condition. On a cash basis, you cannot measure the pay you will earn or expenditures in the future. But using accrual, you can calculate the company’s financial condition more accurately, including the future transactions of the projects you have already started but haven’t earned income for.
Also read: What is Debt to Asset Ratio – Simplest Explanation + Example]
Frequently Asked Questions
A cash basis of accounting is one of the two accounting methods that records income and expenses only when the cash is received.
The disadvantages of a cash basis are it is short-term, not accurate, and restricted by the IRS.
It is easy to implement cash-based accounting, but it is not accurate compared to an accrual basis.
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