Cash accounting is a type of accounting that keeps track of payments as they are received and made. These are some of the few advantages and disadvantages of the business cash accounting system.
Businesses that use the cash accounting method track revenue as it is received and expenses as it is paid. The accrual method of accounting, which mandates that companies record income as it is earned and expenses as they are incurred, is different from this accounting technique.
How Cash Accounting Operates
Regardless of when the service is given, businesses that employ cash accounting record income in their books whenever they receive a cash payment. Therefore, you will still record the income when you receive it if a client elects to prepay for a year’s worth of legal services after the previous year.
Cash accounting examples
Let’s imagine that in June, you spent $20,000 on furniture for your office. Then, in July, you paid the furniture shop $20,000. Even if you received the table a month earlier, you would be documenting the transaction (of cash paid) in July under the cash accounting method because that is precisely when the cash was paid to the furniture store.
Cash accounting’s shortcomings
The restrictions on cash accounting are as follows:
Although it displays current cash, it only depicts part of the picture. For instance, liabilities that your company still needs to pay are not displayed in cash accounting. As a result, it presents a distorted view of your company’s performance, which is harmful to long-term choices.
As a business’s revenue increases, its inventory increases, and it becomes a larger organization, it must eventually switch to the accrual accounting technique. In addition, companies that currently utilize cash accounting but anticipate receiving outside funding must switch to the accrual accounting system.
Positive aspects of cash accounting
The benefits of cash accounting are listed below:
Simple to implement
Cash accounting is simple, and you can start using it immediately to run your firm. Comparing it to accrual accounting, it is less time-consuming and easier to grasp others, making it simpler to implement.
Accurate insight into cash flow
It displays the company’s current cash flow. It merely shows a company’s cash amount at any particular time without considering the past or future. This can be an excellent approach for startups and small enterprises to always be aware of their cash flow.
It makes tax returns easier.
For some MSMEs, filing tax returns is simple with cash accounting. For example, say a customer owes you money. Since they have yet to pay, your tax burden for the current fiscal year is smaller because you will only have to account for it once the money flows into your company. This is advantageous for substantial payments.
Accounting on a cash basis is a relatively simple process. However, it only provides business owners with a short-term snapshot of their financial status because it excludes unpaid bills and sales invoices.
With that said, Cash accounting should be used by something other than large organizations, businesses with inventory, or firms with a double-entry accounting system. It shouldn’t be used by companies with a large workforce or by those with many everyday transactions. Since it makes it more logical, accrual accounting is preferred and more appropriate for any organization that regularly publishes financial records. When a transaction involves credit, accrual accounting is the better choice.