Cash Basis Accounting

1. Definition

Cash Basis Accounting is an accounting method that records revenue and expenses only when cash is actually received or paid.

It operates exactly like a personal checkbook or a household ledger. Revenue is not recognized until the money hits the bank account, and expenses are not recognized until the money leaves the account.

2. Key Principle: Cash Movement

Unlike Accrual Accounting, which focuses on economic events, Cash Basis Accounting focuses strictly on cash flow.

• Revenue Recognition: Even if goods are delivered, it is not revenue until the cash is collected.
• Expense Recognition: Even if a bill is received, it is not an expense until the payment is made.

3. Example (vs. Accrual)

Suppose a company buys office supplies for $1,000 using a credit card in December, and pays the credit card bill in January of the following year.

A. Cash Basis

• December: No cash left the account, so Zero Expense recorded.
• January: Cash is paid, so $1,000 Expense recorded.

B. Accrual Basis

• December: The purchase occurred, so $1,000 Expense recorded immediately. (Recorded as Accounts Payable).
• January: No new expense. The transaction is just settling the debt.

4. Advantages

• Simplicity: It is very easy to maintain and understand, requiring no advanced accounting knowledge.
• Cash Visibility: The profit shown on the books matches the actual cash balance, eliminating confusion about liquidity.
• Tax Deferral: For small businesses, taxes are often paid only on cash received, not on invoices issued, which can help with cash flow management.

5. Limitations

• Distorted Performance: If you work hard in December but get paid in January, December looks like a bad month and January looks like a great one. It fails to match effort with result (violates the Matching Principle).
• Limited View: It does not track accounts receivable (money owed to you) or accounts payable (money you owe), making it difficult to see the company's long-term financial obligations.