Cash Basis Accounting

The most simple method of accounting is a single entry system and works on the principle of cash basis accounting. For these purposes, cash is not only considered to be banknotes and coins but also debit/credit card transactions and wire transfers or EFT payments. Purchases or sales made on credit are not cash transactions. Cash basis accounting records transactions as they happen on a cash-in and cash-out basis. It, therefore, cannot keep track of debtors, creditors or provide the net asset value of the business.

The Advantages of Cash Basis Accounting

For a small business that does not buy or sell on credit, does not own a lot of equipment or vehicles and does not own fixed assets like property, a cash basis accounting system is usually the preferred method. Because of its simplicity, cash basis accounting does not require a trained accountant or bookkeeper. A business that is required to provide a balance sheet to shareholders or authorities, or where local taxation laws prohibit the use of a single entry system, cannot use cash basis accounting methods. In these cases, a double-entry system needs to be employed.

The Difference Between Cash Basis Accounting & the Double-Entry System

To explain the difference between a double-entry and cash basis accounting system, we can look at the following transaction. A business pays cash for stock that will be delivered at a later date. A double-entry system is required to reflect the net asset value of the business at all times. This means that this transaction has to be recorded in two parts—effectively there are two transactions—each requiring two ledger entries (one debit and one credit).

When payment is made for the stock, a credit entry is made to the bank account and a matching debit entry is made to a debtor account in the name of the stock supplier. At this point in the transaction, the supplier is a debtor in that they owe the stock to the purchaser. When the stock is delivered, a credit entry is made to the debtor account and a debit entry is made to the stock account. Using a cash basis accounting system, only one entry is made. The payment for the stock will be entered as a cash-out entry, the asset value of the stock or debtor accounts is not required, as these are not cash assets.

Using a cash basis system, one is able to track all income and expenditure. This allows the owner to keep track of cash flow and calculate their profit for both their own purposes and that of submitting their income for tax purposes.