Accounting - The Cash Basis

In accounting, the cash basis means that a company will only record revenue when it receives cash from its client, or when it pays out cash. Usually, small businesses or individuals, especially those who do not have inventory, will prefer using this method.

Another way of recording business transactions is by using the accrual basis, which is the method that most accounting firms in Johor Bahru would use when they are doing the accounting-related tasks for their customers. This means that the accountant should record the revenue once the company had earned it and record the expenses when it consumed its assets or liabilities have incurred, regardless of the timing of the associated cash flow (Also see Differences Between the Accrual Basis and Cash Basis of Accounting). Usually, the sizable entities will prefer using this method. For a start-up company, its business owner may choose to use the cash basis to keep the books before changing to the accrual basis when it develops until it is sufficiently large.

Typically, the accountants may set a flag in the setup table of accounting software to determine whether they want the software to work under the accrual basis or the cash basis.

There are some advantages that the companies which use the cash basis of accounting can obtain, which are from the aspects of:

Ease of use

Business owners do not need to be professional in accounting for them to keep the records by using the cash basis of accounting.

Taxation

Usually, companies that choose to use the cash basis do so for tax purposes. This is because it is easier for them to settle some payments earlier so that their taxable profits will decrease. This helps to defer some of its tax liabilities.

However, companies that use the cash basis may need to face some of its disadvantages:

Manipulation

It is easy for business owners to change their reported results. For example, they may choose not to cash the cheques they have received or change the timing for them to pay for its liabilities.

Auditing

The auditors will not approve the financial statements that the company has prepared by using the cash basis (Also see Principles of Auditing).  Thus, if the business owners wish to get their financial statements audited, they need to change the cash basis it is using into the accrual basis.

Accuracy

Compared to the accrual basis, the results of the cash basis are not so reliable. This is because the timing of cash inflows and outflows may not show the accurate timing of the change of the company’s financial position. As an instance, if the contract states that it is not allowable for the company to issue the invoice to the client as long as the project has not ended, the company will not be able to record any revenue until it can issue the invoice and collect payment from the client.

Management reporting

The company cannot issue management reports that it has prepared using the cash basis of accounting since the financial statements that are based on might not be accurate.

Difficulty in acquiring loans

Most of the lenders do not think that the financial statements that the company generates under the cash basis of accounting are accurate. Thus, they may not want to lend money to those companies that use the cash basis.

In short, most of the companies will stop using the cash basis of accounting after their initial start-up stage as the business owners may face various problems if they continue using it.