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:
- For simpler accounting systems with accounting personnel who are not familiar with the more intricate accrual basis of accounting
- Where there is no inventory to be tracked or valued
- Where there is no need for an audit, as may be required by a lender
- When the company is in the services business (which implies that there is no inventory)
The cash method 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.
Cash basis is also known as the cash system of accounting.