The cash basis is a method of recording accounting transactions for revenue and expenses only when the corresponding cash is received or payments are made. Thus, you record revenue only when a customer pays for a billed product or service, and you record a payable only when it is paid by the company. Many small business owners may be using the cash basis without even realizing it, if they are recording business transactions primarily with a check book.
Cash basis accounting is allowed for tax purposes only for smaller entities, and is not acceptable under generally accepted accounting principles or international financial reporting standards. The cash basis is useful under the following circumstances:
Where there is no inventory to be tracked or valued
When the company is in the services business (which implies that there is no inventory)
The cash basis can yield inaccurate results, because revenues may be recognized in a different period than the period in which related expenses are recognized. The result can be incorrectly high or low reported profits, leading to an impression that the profits of a business vary by large amounts from month to month when that is not necessarily the case.
The cash basis is also known as the cash system of accounting.