What is the Cash Method of Accounting?
Written by Eddy Hood
Using the most appropriate accounting method can help a company save money and simplify their bookkeeping procedures. At Ignite Spot, we strive to keep our clients informed of all of their accounting options. By keeping our clients in the loop, we can be as responsive as possible to each company's needs. One of the questions we hear from clients most often is: What is the cash method of accounting?
Most businesses use either cash-basis accounting or accrual-basis accounting to keep track of their accounts. While larger businesses use the latter method as a matter of course, smaller businesses may have the option to choose between the two systems for their particular needs. The cash method of accounting is so named because it works most effectively for businesses that rely on cash-based transactions. However, the method is not actually tied to a single method of payment. Rather, cash-based accounting and accrual-based accounting methods vary in when they record transactions. With the cash accounting method, each transaction is recorded as taking place when the money actually changes hands. With the accrual method, transactions are recorded at the time of the sale, regardless of when payments are made.
Since the cash method of accounting focuses on when the payments are actually made, it gives a clear picture of how much money is in a company's bank accounts at any given time. However, in some cases, cash-based accounting can also give a misleading picture of a company's financial standing. For example, if a company has made a large purchase on credit, it's useful to include the upcoming expense in the overall financial picture. The difference between the two accounting methods is most clear in payments made on credit, which may cause a payment to be made in a different month, fiscal quarter, or even fiscal year than when the services where rendered.
The cash accounting method can prove appealing to smaller businesses in certain situations. For example, a small business may provide services in one year but not receive payment for those services until the following year. Using the accrual method, the business would nonetheless be obligated to pay taxes on the services, even if they had not yet received any payment. The cash method, on the other hand, lets the business wait to pay taxes until they have actually received payment.
In practice, cash-basis accounting is only relevant to certain kinds of businesses. Corporations with billings exceeding $5 million are obligated to use the accrual method. Likewise, companies that stock and sell inventory to the public must use the accrual method. Regardless of these criteria, it's a good idea for any business owner to be able to answer the question: What is the cash method of accounting?
At Ignite Spot, we're committed to helping individual businesses identify the best accounting methods for their needs. Our firm finds the best accounting and bookkeeping methods to help our clients turn profits and achieve goals. Along the way, we strive to keep clients informed. To start the process, our representatives can answer questions and clients may download free informational materials.
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