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Cash Basis Accounting Method: Definition & Example

Instructor: Tiffany Spencer

Tiffany has taught ESL online and has a master's degree in business administration.

This lesson defines cash basis accounting and describes the differences between this type of accounting and other accounting methods. It also discusses the type of organizations that typically use cash basis accounting, and gives an example of how cash basis accounting works.

Cash Basis Accounting

Cash basis accounting is an accounting method wherein revenue and expenses are recorded when a payment is received or made. In other words, if you perform services or sell a product, you don't count this as income until your customer actually pays you. Likewise, if you have a business expense, you don't record it when it is billed or due, you record it when it is paid. If you can imagine holding all of your business's money in one hand, you wouldn't record anything in your accounting system unless money came into your hand, or money was paid out of your hand.

Disadvantage of Cash Basis Accounting

Unlike other methods of accounting, cash basis accounting does not match expenses to income in a given period. This can be problematic for businesses because it can be difficult to track profitability on a real-time basis. Customers may pay for services or products, which will count as income, while the related expenses may not yet be paid. This sort of situation may overstate or understate the income for a particular period.

Organizations that use Cash Basis Accounting

Most individuals and small business owners use the cash basis accounting method because it is generally easy to understand. Another benefit to individuals and small business owners is that the cash basis accounting method generally does not require any special accounting training or skill. However, some businesses must use another method. For instance, businesses that have inventory must use the accrual method, which records revenue and expenses when they occur not when cash is exchanged. Additionally, large corporations or partnerships with corporate partners (with earnings over $5 million) may not use the cash basis accounting method.

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