Cash accounting is an accounting method that records financial transactions when cash is exchanged between parties, regardless of the delivery of goods or services. This method of accounting is typically used by small businesses with limited accounting resources to track income and expenses for tax purposes. It is also commonly used in personal finance to manage personal income and expenses.
Example of Cash Accounting
Suppose a company provides landscaping services to a customer and sends the invoice for $100 in April. Assuming the customer pays the invoice amount in June, the cash basis accounting would recognize the revenue in June when the cash is received, even though the service was provided in April.
If the same company paid for a landscaping tool in March, the expense would not be recognized until it is paid in March, regardless of the month it was used.
Cash Accounting vs. Accrual Accounting
Accrual accounting is another accounting method that records revenue and expenses when they are earned or incurred, not when they have been paid or received.
In contrast to cash accounting, accrual accounting provides a more accurate picture of the company’s financial position since it adjusts for the timing of revenue recognition and expenses. Accrual accounting is used by large businesses, corporations, and government agencies.
In the same example, a company using accrual accounting would recognize the revenue at the time the service is provided, instead of when the cash is received. If the company provided landscaping services in April, it would recognize the revenue in April, regardless of whether cash was received.
Similarly, if the company paid for a tool in March, but it was used in April, it would recognize the expense in April when the tool was used instead of when it was paid.
Cash accounting is a simpler method than accrual accounting. With cash accounting, revenue and expenses are recognized only when cash is exchanged, providing a more straightforward view of the business’s financial position. However, cash accounting may not provide a complete picture since it does not adjust for the timing of revenue recognition and expenses.