Cash basis accounting is the preferred accounting method of individuals and small businesses. It has an easy-to-implement core strategy: money is recorded as it is received, and expenses are recorded as they are incurred. Accountants report income and expenses during the period when money actually changes hands. For instance, if a company delivered an order in June and the payment was due in July, the revenue would be recorded in July. Cash basis differs from accrual based accounting, where sales are recorded when they are earned and expenses when they are incurred, but not necessarily paid.

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Accrual accounting

As you research cash based accounting, you will find it is often compared to what it is not: accrual accounting. Accrual accounting is more complex, but may present a more accurate picture of a company's finances. Money is recorded as earned when a sale is made, but not necessarily when you receive the money; the same with expenses. In addition, accrual accounting is a must for adhering to the the generally accepted accounting principles (GAAP).

I recommend: NfpAccounting Technologies has a great rundown of cash based vs. accrual accounting.

Revenue

In cash basis accounting, revenue is recorded when it is received. If your company has accounts receivable, cash basis accounting could make its books look bleak.

I recommend: Understand Accounting summarizes the benefits and disadvantages of cash basis accounting.

Expense

Expenses are only recorded in the period they are paid out in cash basis accounting. If your company is in debt, a cash basis accounting report would not accurately reflect this liability.

I recommend: BusinessTown.com explains how expense fits in with other accounting concepts like assets, liabilities and income.

Cash basis tax reporting

It is sometimes necessary to ask the Internal Revenue Service (IRS) if you can switch bookkeeping methods, especially if you have a large company and you want to switch from accrual to cash basis. Most companies are, in fact, required to use accrual basis reporting when filing taxes. But with cash basis tax reporting, you are not taxed on invoices you have not actually received.

I recommend: Crowe Horwath advises companies in the agriculture industry on whether cash basis accounting is right for them.

Profit and loss report

The biggest disadvantage of a cash basis accounting system is that it does not provide an accurate profit and loss report. Cash basis profit and loss report shows what a company's accounts look like at any given moment. It often does not accurately reflect recent increases or decreases in productivity. For that, accrual accounting provides a much more accurate picture. It is, however, a good indicator of cash flow.

I recommend: Law Practice Today has an article on the advantages and disadvantages of cash basis accounting in a law firm.

Depreciation

To use cash basis accounting, you would pay for equipment upfront and write the entire cost off as an expense that year, as opposed to stretching out the depreciation over the life of the equipment.

I recommend: The IRS has a good explanation of depreciation.

Cash basis accounting is an accounting process in which you record all transactions when you receive a cash payment from customers or pay out cash to vendors for products or services. You can’t use cash basis accounting if you sell products or services on store credit or if you bill customers for services after the service has been rendered.

In addition to cash basis accounting, you can also record transactions using a method called accrual accounting. WWith accrual accounting, you record transactions in the books as soon as they occur—even if no cash is exchanged. Take the following steps to determine if cash basis accounting is right for your business:

1. Evaluate the benefits of cash basis accounting for your business transactions.

2. Rely on advice from a cash basis accounting expert.

3. Automate your cash basis accounting processes.

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Get cash basis accounting advice

Cash basis accounting is great for recording cash flow, but doesn't do such a good job in helping you to match revenues with expenses. Modified cash basis accounting and strict cash basis accounting are two forms of this accounting method. The strict form directly follows the cash flow, while modified includes elements of accrual accounting.

I recommend: nfpAccounting Technologies offers online advice on the differences between cash basis accounting and accrual accounting and helps you decide which method is best for your business. Stephen L. Nelson advises business owners on accounting methods and helps companies convert from cash basis accounting to accrual accounting.

Talk to a consultant for cash basis accounting

Cash basis accounting usually isn't an acceptable accounting method for public companies. Be sure that you consult with an expert to fully understand all governmental reporting requirements with which you must comply.

I recommend: Haskins & Associates provides business owners with cash basis accounting information and advises on the best accounting strategies for specific types of businesses. Get free accounting advice online from Beir Accounting, a professional association of accountants offering cash basis accounting consulting and other accounting services to small business owners.

Purchase cash basis accounting software

Cash basis accounting is generally the preferred form of accounting for small business owners, because it's the simplest method to track business transactions. You can purchase software to help you automate your accounting processes.

I recommend: Plumbline Solutions sells cash basis accounting software to help you automate your accounting procedures. QuickBooks is a leading small business financial software provider that helps you easily record business transactions, including using the cash basis accounting method.

Tips & Tactics

Helpful advice for making the most of this Guide

• •  Consider how cash basis accounting will impact your tax filings. Choosing the cash basis accounting method could greatly affect your taxes, because you can only deduct the actual cost of the purchases made in a specific tax year with this method.