Cash basis income statement definition
/What is a Cash Basis Income Statement?
A cash basis income statement reports revenues when cash is received and expenses when cash is paid. It does not recognize receivables, payables, or accruals. As a result, reported income reflects cash flows rather than economic activity for the period. This format is commonly used by small businesses for internal or tax purposes rather than external financial reporting.
Disadvantages of a Cash Basis Income Statement
Here are some disadvantages of issuing a cash basis income statement:
Misleading profitability. Revenue and expenses are recorded only when cash is exchanged, which can distort profitability in periods with delayed payments or prepayments.
Poor matching of revenues and expenses. Cash basis accounting fails to match revenues with related expenses in the same period, making it hard to assess the actual profitability of specific activities or projects.
Not GAAP compliant. Cash basis accounting does not comply with Generally Accepted Accounting Principles (GAAP), limiting its use for medium and large businesses that require audited financial statements.
Inability to secure financing. Lenders often prefer accrual-based financial statements because they provide a more accurate view of financial health, making it harder for companies using cash basis to obtain loans or attract investors.
These limitations make cash basis accounting less suitable for businesses seeking a comprehensive understanding of their financial condition.
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Presentation of a Cash Basis Income Statement
Because of the important timing difference between a cash basis income statement and an accrual basis income statement, you should always prominently label the income statement using a format similar to the following:
ABC Company
Cash Basis Income Statement
for the month ended xx/xx/xxxx
To be even more clear for any reader of the income statement who did not see the revised header, you should relabel the "Net income" line with "Cash basis net income".
Better yet, add a footer to the income statement, stating:
Cash Basis Income Statement - Not Prepared Under Generally Accepted Accounting Principles
How to Adjust a Cash Basis Income Statement to an Accrual Basis Income Statement
The key steps involved in adjusting a cash basis income statement to an accrual basis income statement include the following items:
Revenue adjustments:
Subtract any billings for which cash was received from customers
Subtract any cash deposits received from customers that have not been earned
Add billings to customers during the period
Add earned but unbilled products/services
Expense adjustments:
Subtract payments made for expenses incurred in a prior period
Subtract any deposits paid for which the expense has not yet been recognized
Add expenses accrued during the period for which there are not yet any supplier invoices
Add supplier invoices received during the period, relating to the current period
Add depreciation and amortization expense, and other non-cash expenses
FAQs
Why can a cash basis income statement misrepresent operating performance?
A cash basis income statement reflects the timing of cash receipts and payments rather than when revenues are earned or expenses are incurred. Management can influence reported results by accelerating collections or deferring payments. This can cause reported income to diverge from the entity’s underlying operating performance.