Cash receipts and cash payments are added together to produce net income on a cash basis. All of the funds you received throughout the accounting period, such as sales revenue, interest income, and loans, are included in your cash receipts. All of the money you spend throughout the accounting period, including rent, utilities, and supplies, is included in cash payments. Your cash basis net income is the difference between cash revenues and cash payments.
It’s crucial to understand that cash basis accounting differs from tax basis accounting. A set of accounting guidelines known as tax basis accounting are only utilized for tax purposes. Depending on their size and income, businesses must utilize accrual basis accounting or tax basis accounting for tax purposes, according to the IRS. Unlike other accounting methods, accrual basis accounting records transactions as they happen, regardless of when payment is received or made.
Taking all of this into account, the cash basis of accounting is unreliable since it cannot accurately depict a company’s financial performance. For instance, even if a company may have made a sale during the accounting period, the income won’t be recorded if the payment is made after the period has ended. Similar to this, even though a company may have incurred expenses during the accounting period, they will not be recorded if payment is made after the period has ended. This may result in erroneous financial reporting and poor cash flow management.
When cash is received or paid, revenues and expenses are recorded on the income statement according to the cash basis of accounting. As a result, revenues and costs are not matched to the accounting period in which they happened. A mistaken perception of a company’s financial performance may emerge from this. In contrast, regardless of when payment is received or delivered, revenues and costs are matched to the accounting period in which they occurred under the accrual basis of accounting. This gives a better representation of a company’s financial performance.
In summary, cash basis accounting is a straightforward accounting technique that logs transactions whenever money is exchanged. Cash receipts and cash payments are added together to produce net income on a cash basis. Cash basis accounting, on the other hand, is not the same as tax basis accounting and is unreliable for giving a reliable picture of a company’s financial performance. Revenues and expenses are reported under the cash basis of accounting when cash is received or paid, which can produce a skewed picture of a company’s financial performance.