Cash-basis accounting

Definition

Cash-basis accounting records revenues and expenses when cash is actually received or paid. It contrasts with accrual accounting, which recognizes revenues and expenses when they are incurred, regardless of cash flow.

5 Must Know Facts For Your Next Test

1. Cash-basis accounting is simpler but less accurate for matching revenues with expenses.
2. This method does not conform to Generally Accepted Accounting Principles (GAAP).
3. It can be useful for small businesses with straightforward financial activities.
4. Cash-basis accounting can distort the true financial position of a company because it doesn't account for accounts receivable or payable.
5. It may not provide an accurate measure of liquidity since it ignores outstanding obligations and future income.

Review Questions

• What is the primary difference between cash-basis and accrual accounting?
• Why might cash-basis accounting not conform to GAAP?
• How can cash-basis accounting affect the measurement of a company's liquidity?

Related terms

Accrual Accounting:

Revenues and expenses are recorded when they are earned or incurred, regardless of when cash transactions occur.

Current Ratio:

A liquidity ratio calculated as current assets divided by current liabilities, indicating a company's ability to pay short-term obligations.

Working Capital:

The difference between a company's current assets and current liabilities, representing the available resources for day-to-day operations.