The Need-To-Know of of Cash Based Accounting
Cash-based accounting is one of the different accounting concepts that you have to keep in mind as a business owner.
Whether you’ve learned about it in an accounting class or heard it through the complaints of a fellow business owner, cash accounting holds significance in any company. If you’re new to the idea of cash accounting and are looking to implement it in your own business, this article is a simple guide that you can use.
What is cash accounting?
Cash accounting—which alternatively known as cash-basis accounting—is an accounting method that revolves around the following practices:
Recording payment receipts during the time they are received
Recording expenses during the period that they are actually paid off
This accounting method, in essence, records expenses only whenever cash is paid and records revenue when cash is received. As opposed to its accrual counterpart, which records an expense or revenue when it occurs, cash-based accounting only records any transaction when the amount itself is actually paid or received. To better understand how this particular accounting method works, let’s look at an example of cash accounting:
Through the cash accounting system, a car manufacturing company A that receives $100,000 from the sale of two family-sized SUVs on November 4 will record the sale on that date as the cash was paid. Although the company B placed a reservation on September 25, this piece of information is irrelevant as cash moved and landed in company A’s hands-on November 4. If company A’s two family-sized SUVs changed hands on November 4 but company B only paid on December 25, however, then the transaction will be recorded on that date instead of November 4.
Why is the cash accounting method used?
Generally, cash accounting is used due to the fact that it is much simpler and more straightforward than the accrual-based accounting method. This case makes it a better option for small business owners that need control over their business’s finances. Additionally, cash accounting also provides a clearer, more “in-the-now” viewpoint simply because it relies on a standpoint that solely deals with the cash that the business has on-hand.
When is it not possible to use the cash accounting method?
The only type of business that is not allowed to use the cash accounting method is corporations. They are required to use accrual accounting under the Generally Accepted Accounting Principles (GAAP).
Does the cash-based accounting method have any limitations?
Although cash-based accounting only has a few limitations, it is vital to take note of them and carefully go over each on if you plan to adopt the method into your operations.
One key pitfall of cash accounting is that it is unable to provide an accurate view of any possible liabilities that may have already been incurred but not yet paid for. This particular limitation may present your business’s finances as better-off than they actually are, potentially leading to a few wrong decisions if you aren’t careful.
Conversely, cash accounting can also make your business’s finances look as if they’re on the losing end, as any pending payments from clients will not be recorded up until the accounts receivable is paid off. The erroneous perception of a business’s finances may lead to an understatement of the business’s financial decision, which may also lead to a few wrong decisions along the way.
Cash-based accounting is a simple yet powerful tool that any business can use to keep track of its numbers and view its finances in a more realistic, as-is manner. By keeping this guide in mind, you can navigate the basics of cash-basis accounting well enough to give your business’s accounting process a much-needed lift for growth and better business decisions.
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