In cash accounting, payment receipts are recorded during the period they are received, and expenditures are recorded during the period they are paid. This differs from accrual accounting, which records expenses when debts are incurred, and recognizes profits when revenue is earned, regardless of when cash is received or paid.
Example of Cash Accounting
A business bills a client for $10,000 in services on October 15 and gets paid on November 15. On November 15, the date of cash receipt, a sale is documented. Similar to this, on July 10 the business receives a $500 invoice from a supplier, which it settles on August 10. The cost is recorded on August 10, which is the date of payment.
- Simple: You must select one of the accounting procedures as a business. This accounting option is the most straightforward because you will simply record transactions involving cash. No consideration will be given to any other transactions.
- Maintenance is easy: An accrual system of accounting is challenging to maintain. The upkeep of cash accounting is rather simple in comparison. When money is received in cash from clients, you will record revenue; similarly, when money is paid in cash to suppliers, you will record expenses.
- Liquidity: Potential investors who wish to invest in the company don't need to pass through a liquidity ratio because all transactions are in cash. They can check the accounting software, check the cash input and outflow, and then determine the company's net cash flow for themselves.
- Single-entry accounting: Single-entry accounting is used here. That implies that only one account is affected by the effect. The business benefits from having things made simpler and is also freed from having to adhere to the matching notion.
- Not very accurate: Since only cash transactions that have been reported and not all transactions have been included. Therefore, we cannot state that it is highly trustworthy. Additionally, this method of accounting records revenue or expenses regardless of the accounting period when the corporation gets or pays cash.
- Not recognized by Companies Act: This accounting is not recognised by the Companies Act, but few businesses use it. Therefore, large corporations do not engage in this technique.
- Chances of discrepancies: Since it simply keeps track of cash transactions, the company may engage in unfair practices by concealing earnings or exaggerating expenses.
When Is Cash Accounting Sufficient?
A large corporation cannot use cash basis accounting. What kind of businesses can use this accounting, though? Simply put, when would this accounting be adequate?
Several requirements must be met to ensure that this accounting method is appropriate.
- When your company is a sole proprietorship or a partnership and it is relatively small.
- When you merely have a few financial transactions to record.
- If staff numbers are relatively low.
- As a firm, you are not required to keep track of income statements, balance sheets, or any other financial information.
- Your business operates entirely on a cash basis and does not involve credit transactions.
- Additionally, your fixed capital is relatively limited.