What Is Cash Basis Accounting for Individuals and Businesses?

Cash basis accounting records when cash actually changes hands in a transaction, providing a real-time view of your financial position that reflects the actual cash flow of a business or individual. While straightforward and easy to understand, it doesn’t account for any pending transactions that may be important to future cash flow and forecasting. Whether you opt for cash basis accounting or a different accounting method, working with a financial advisor could help you create a sustainable plan for your business or finances.

What Is Cash Basis Accounting?

Cash basis accounting is a method of recording financial transactions when cash is received or paid out. This method is typically used by small businesses and individuals because it’s simpler to understand and manage. For example, a small business that uses cash basis accounting would only record a sale in its accounts when the customer has paid the invoice. This means revenue is recorded when it's actually received, and expenses are recorded when they're actually paid. It offers a clear picture of the actual cash flow at any given point in time without the need to project pending transactions that haven't been settled.

Pros of Cash Basis Accounting for Individuals and Businesses

Cash basis accounting indicates when money has actually been received and helps people keep track of their finances on the go. Here are six general ways you could benefit from this type of accounting: 

• Simple and easy to understand. It’s more straightforward to implement, making it ideal for small businesses and individuals.
• No complex accounting adjustments needed. The cash basis method means you don’t have to make complicated financial accounting adjustments, like the accrual method does. This helps you more easily keep track of your financial health in real-time and also keep transaction errors to a minimum.
• Easier to understand for non-accountants. The process is helpful to people or industries where non-accountants might be completing the bookkeeping tasks. It's simple to learn and allows them to do the accounting for themselves.
• Inexpensive. Fewer resources and less time are necessary to manage cash basis accounting. So, it’ll also cost less to maintain the practice than another method. For example, you might be able to do it yourself rather than figure out how much a CPA will cost your small business.  
• Reflects actual cash flow. It gives an accurate picture of cash flow in real-time since transactions are recorded only when funds shift hands.
• Tax savings opportunities. You could potentially rely on cash-basis accounting methods to put off taxable liabilities until a future year. You can also better claim expenses against payments for tax purposes.

Cons of Cash Basis Accounting for Individuals and Businesses

Cash basis accounting doesn't provide a complete view of the financial health of a business or individual because it doesn't take accounts receivable into consideration. Here are three additional drawbacks to keep in mind when using cash basis accounting: 

• Doesn't reflect outstanding invoices. Since transactions are only recorded once the funds change hands, transactions that are agreed to but remain outstanding are not represented in your accounting yet. In the case of a large invoice, this could misrepresent the financial health of the individual or business.
• Potential for misrepresentation of financial position. Because invoices and accounts are not recorded until the money has changed hands, cash basis accounting does not reflect the full account balances of entities.
• Little ability to predict future resources or needs. Since accounting is not made on a planned basis, it can be harder to accurately predict upcoming financial needs.

Cash Basis vs. Accrual Method Accounting

The key difference between the cash basis and accrual method accounting is the timing of when the transactions are recorded.

Small businesses or individuals often use the cash basis method because it’s simpler, tracking only actual cash transactions, which makes it easier to see cash on hand. This method can suit small or cash-only businesses well.

Larger businesses, or those with more complex transactions involving credit or inventory, typically prefer accrual accounting. This method records revenues and expenses when they occur, not when cash changes hands, thereby providing a clearer picture of financial health over time.

If you use the accrual method, note that businesses should adhere to generally accepted accounting principles (GAAP) for auditing or investment purposes.

Bottom Line

Cash basis accounting can be beneficial for small businesses and individuals who want a real-time picture of cash flow. However, it has limitations. Because this method doesn’t account for outstanding invoices, it could potentially misrepresent the financial position, especially when large transactions are involved.

Small Business Tips

• If you need help, a financial advisor can help you create a cash flow process that works for your business. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now.
• If your tax bill from last year seemed high, you may not have been getting all possible small business tax write-offs. Here's a breakdown of credits that you should consider.

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