Guide to Cash Basis Accounting Key Terms

Find out if cash basis accounting is the system for you by learning key terms

By Elise Matz

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Cash basis accounting is the preferred accounting method of individuals and small businesses. It has an easy-to-implement core strategy: money is recorded as it is received, and expenses are recorded as they are incurred. Accountants report income and expenses during the period when money actually changes hands. For instance, if a company delivered an order in June and the payment was due in July, the revenue would be recorded in July. Cash basis differs from accrual based accounting, where sales are recorded when they are earned and expenses when they are incurred, but not necessarily paid.

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Accrual accounting

As you research cash based accounting, you will find it is often compared to what it is not: accrual accounting. Accrual accounting is more complex, but may present a more accurate picture of a company's finances. Money is recorded as earned when a sale is made, but not necessarily when you receive the money; the same with expenses. In addition, accrual accounting is a must for adhering to the the generally accepted accounting principles (GAAP).

I recommend: NfpAccounting Technologies has a great rundown of cash based vs. accrual accounting.

Revenue

In cash basis accounting, revenue is recorded when it is received. If your company has accounts receivable, cash basis accounting could make its books look bleak.

I recommend: Understand Accounting summarizes the benefits and disadvantages of cash basis accounting.

Expense

Expenses are only recorded in the period they are paid out in cash basis accounting. If your company is in debt, a cash basis accounting report would not accurately reflect this liability.

I recommend: BusinessTown.com explains how expense fits in with other accounting concepts like assets, liabilities and income.

Cash basis tax reporting

It is sometimes necessary to ask the Internal Revenue Service (IRS) if you can switch bookkeeping methods, especially if you have a large company and you want to switch from accrual to cash basis. Most companies are, in fact, required to use accrual basis reporting when filing taxes. But with cash basis tax reporting, you are not taxed on invoices you have not actually received.

I recommend: Crowe Horwath advises companies in the agriculture industry on whether cash basis accounting is right for them.

Profit and loss report

The biggest disadvantage of a cash basis accounting system is that it does not provide an accurate profit and loss report. Cash basis profit and loss report shows what a company's accounts look like at any given moment. It often does not accurately reflect recent increases or decreases in productivity. For that, accrual accounting provides a much more accurate picture. It is, however, a good indicator of cash flow.

I recommend: Law Practice Today has an article on the advantages and disadvantages of cash basis accounting in a law firm.

Depreciation

To use cash basis accounting, you would pay for equipment upfront and write the entire cost off as an expense that year, as opposed to stretching out the depreciation over the life of the equipment.

I recommend: The IRS has a good explanation of depreciation.