What is 'Cash Accounting'

Cash accounting is an accounting method in which payment receipts are recorded during the period they are received, and expenses are recorded in the period in which they are actually paid. In other words, revenues and expenses are recorded when cash is received and paid, respectively.

Cash accounting is also called cash-basis accounting.

BREAKING DOWN 'Cash Accounting'

Cash accounting is one of two forms of accounting. The other is accrual accounting, where revenue and expenses are recorded when they are incurred. Small businesses often use cash accounting because it is simpler and more straightforward and it provides a clear picture of how much money the business actually has on hand. Corporations, however, are required to use accrual accounting under Generally Accepted Accounting Principles (GAAP).

Under a cash accounting system, if Company A receives $10,000 from the sale of 10 computers to Company B on Nov. 2, the accountant records the sale as having occurred on Nov. 2. The fact that Company B placed the order for the computers on Oct. 5 is irrelevant, because it did not pay for them until they were delivered on Nov. 2. Under accrual accounting, by contrast, the accountant would have recorded Company A as having received the $10,000 on Oct. 5, even though no cash had changed hands yet. 

Under cash accounting, companies record expenses when they actually pay them, not when they incur them. If Company C hires Company D for pest control on Jan. 15 but doesn't pay the invoice for service completed until Feb. 15, the expense would not be recognized until Feb. 15 under cash accounting. Under accrual accounting, however, the expense would be recorded in the books on Jan. 15.

A drawback of cash accounting is that it may not provide an accurate picture of liabilities that have been incurred but not yet paid for, so the business might appear to be better off than it really is. At the same time, cash accounting means that a business that has just completed a large job for which it is awaiting payment may appear to be less successful than it really is, because it has expended the materials and labor for the job but not yet collected payment. Therefore, cash accounting can overstate or understate the condition of the business if collections or payments happen to be particularly high or low in one period versus another.

There are tax consequences for businesses that adopt the cash accounting method of recognizing cash inflows and outflows. In general, businesses can only deduct expenses that are recognized within the tax year. The choice of revenue/expense recognition method can determine which year a business can deduct its expenses. If a company incurs expenses in December 2017, but does not make payments against the expenses until January 2018, it would not be able to claim a deduction for the fiscal year ended 2017, which could significantly affect the business' bottom line. Likewise, a company that receives payment from a client in 2018 for services rendered in 2017 will only be allowed to include the revenue in its financial statements for 2018.

RELATED TERMS
  1. Accounting Method

    Accounting method refers to the rules a company follows in reporting ...
  2. Cash Basis

    A major accounting method that recognizes revenues and expenses ...
  3. Modified Accrual Accounting

    An accounting method commonly used by government agencies that ...
  4. Accruals

    Accruals are earned revenues and incurred expenses that have ...
  5. Cash Cost

    Cash cost is a term used in cash basis accounting (as opposed ...
  6. Accounting Period

    The time span in which certain financial events took place. The ...
Related Articles
  1. Investing

    How To Decipher Accrual Accounting

    Accrual accounting is an important method of measuring the performance and position of a company. Learn more on how its used.
  2. Investing

    The Importance Of Analyzing Accounts Receivable

    While investors often focus on revenues, net income, and earnings per share, they should not overlook the importance of analyzing accounts receivable.
  3. Personal Finance

    Accountant: Job Description & Average Salary

    Discover what the job description of an accountant entails, along with education and training, salary and skills necessary for success.
  4. Investing

    Corporate cash flow: Understanding the essentials

    Tune out the accounting noise and see whether a company is generating the stuff it needs to sustain itself.
  5. Investing

    Cash Flow on Steroids: Why Companies Cheat

    Pressure to be the best can sometimes push corporations to cheat. Learn how they do it and how to spot it.
  6. Investing

    What Is a Cash Flow Statement?

    The Cash Flow Statement measures whether a company generates enough cash to meet its operating expenses.
  7. Investing

    Why Cash Management Is Key To Business Success

    Businesses need to generate a healthy cash flow to survive, but not hold too much so that inventory suffers or investment opportunities are missed.
RELATED FAQS
  1. When are businesses required to use accrual accounting?

    Determine when the accrual accounting method must be used instead of cash accounting. Most businesses use accrual accounting ... Read Answer >>
  2. Why does GAAP require accrual basis rather than cash accounting?

    Discover why GAAP requires the accrual basis for accounting rather than the cash basis, and learn why it is important for ... Read Answer >>
  3. What is the difference between an accrual and an account payable?

    Understand the difference between an accrual and an account payable. Learn how an accrual and an account payable affect a ... Read Answer >>
  4. What is accrual accounting in SAP?

    See how accrual accounting practices are handled through the Statutory Accounting Principles and the Systems, Applications ... Read Answer >>
  5. What is the difference between deferred revenue and accrued expense?

    Understand the differences between deferred revenue and accrued expenses. Learn how each is recognized on the balance sheet ... Read Answer >>
  6. How should investors interpret accounts receivable information on a company's balance ...

    Analyze accounts receivable information on a company's balance sheet carefully. Receivables offer confidence of future cash ... Read Answer >>
Hot Definitions
  1. Capital Asset Pricing Model - CAPM

    Capital Asset Pricing Model (CAPM) is a model that describes the relationship between risk and expected return and that is ...
  2. Return On Equity - ROE

    The profitability returned in direct relation to shareholders' investments is called the return on equity.
  3. Working Capital

    Working capital, also known as net working capital is a measure of a company's liquidity and operational efficiency.
  4. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  5. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  6. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
Trading Center