Cash accounting – What is cash accounting?
Cash accounting is an accounting method that records income when it’s received and records expenses in the period in which they are paid.
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There are three important things to keep in mind when determining whether cash accounting is the right method for your business.
Firstly, even when a company is paid through some type of barter arrangement, these transactions must be recorded at the fair market cash value of what was sold or received.
Secondly, when using cash accounting, a company can’t delay the recognition of income. Income must be recognised when it’s constructively received. Income is constructively received when money is made available to the seller (whether by being posted to their account or received by their agent).
For example, if a cheque is received on the 29th of the month, but not cashed or deposited at the bank until the 2nd of the following month, it still must be recognised as income in the first month.
Finally, the cash accounting method has implications for tax. Under this method, it’s only possible to deduct the expenses that are incurred during the accounting year, so it may have an impact on a company’s net income.
Under cash accounting, revenues and expenses are recorded at the time that cash is exchanged. When cash is received from a sale, it’s recorded in the accounts as a sale, and when payment is made on an expense, it’s recorded as an expense.
Cash accounting is one of the two main accounting methods, accrual accounting being the other. In the accrual accounting method, revenue and expenses are recorded when they are incurred - regardless of when cash actually changes hands.
The cash method of accounting is easy to apply. When a company receives money from a customer or pays one of its suppliers, these transactions are recorded and recognised for tax purposes.
Because it’s such a straightforward way of recording a company’s income and expenses, it’s often a choice for small businesses and sole traders who make under £85,000 a year.
Using cash accounting gives you an immediate and up-to-date picture of your cash flow and balances. This can be useful for a small business that might not want to get caught up in too much credit and loans.