What does Cash Basis mean?
Cash basis is an accounting method where income and expenses are recorded when cash is received or paid. This means that revenue is recognized when payment is received, and expenses are recognized when payment is made.
For example, if a business sells a product in December, but the customer pays for it in January, the revenue would be recorded in January under cash accounting. Similarly, if a business receives an invoice in December, but pays it in January, the expense would be recorded in January under cash accounting.
Cash accounting is simple and easy to understand, making it a popular choice for small businesses. It also provides a clear picture of the company's cash flow, as it only records transactions when cash is exchanged. However, cash accounting can result in distorted financial statements since it does not always reflect the economic activity that occurred in the period. For example, if a company receives a large bill in December but doesn't pay it until January, it may look like the company had a more profitable December than it did, and a less profitable January.
Cash accounting is generally not suitable for larger businesses or those that want to gain a more accurate view of their financial performance. In such cases, accrual accounting, where revenue and expenses are recorded when they are incurred rather than when cash is exchanged, may be more appropriate.