By CFO Brew Staff
less than 3 min read
Definition:
Cash basis accounting records revenues and expenses at the moment money is received or spent. For example, a catering company receives a check in June to serve a December event. In the cash basis accounting system, that income would be entered into the books as revenue in June, even though the service won’t be rendered for six months. And if the company buys supplies in August, those expenses would be recognized in August. In other words, events get entered into the accounting ledger as they happen, regardless of when the revenue is earned or expenses are incurred.
Businesses have multiple options when it comes to deciding which accounting method to use. The two most common methods are cash basis accounting and accrual accounting. But how to decide whether using the cash basis or accrual accounting method is better for your business?
The answer can often depend on the size of the business. For small businesses, cash accounting is often easier and a more straightforward way of managing the business. But to help you decide whether cash basis accounting is right for your business, we’re diving deep into what exactly it is and how to use it.
How is cash basis accounting different from accrual accounting?
In contrast, accrual accounting records revenues when they’re earned and expenses when a service is delivered. In the catering company example above, under accrual accounting, the revenue for the event would be recorded in December, when the company delivers the paid-for service, regardless of when the customer sent the check in, and associated expenses would also be recognized in December, no matter when the company purchased the supplies.
What are the advantages of cash basis accounting?
Cash basis accounting is a simpler system and allows companies to see the real-time flow of cash through the business. Small businesses can skip trying to forecast future revenues and expenses based on service delivery under cash basis accounting, because income and expenses are recorded as they happen.
What are the disadvantages of cash basis accounting?
However, it is harder to get a true sense of a business’s performance because cash basis accounting is more of a snapshot of business activity at a given moment. Accrual accounting allows businesses more insight into what future performance looks like, because it allows companies to project activity into the future. It’s also worth noting that cash basis accounting, while convenient, is not GAAP compliant, and the IRS and SEC require that many types of businesses use accrual accounting.
