Cash Basis Net Income: What It Is and Why It Matters for Your Business

The accrual basis of accountingrecognizes revenues when earned (a product is sold or a service hasbeen performed), regardless of when cash is received. Although the company has received no cash, the revenue isrecorded at the time the company performs the service. Later, whenthe company receives the cash, no revenue is recorded because thecompany has already recorded the revenue.

Now, when you look at your income statement, you can see that the job was actually quite profitable. Let’s look at an example of how cash and accrual accounting affect the bottom line differently. We’ll use a hypothetical web design company, and examine a month of transactions. Because this method gives you a more complete picture of your business’s finances, it’s more commonly used than the cash method.

Downsides of accrual accounting

If you take a look at the accrual basis income statement, you’ll see that it more accurately reflects the activity that took place in the month of December. Even though you will not be paid for the office cleaning jobs you completed until January, you are still recognizing that you did perform those services. cash basis accounting measures income based on Your customer paid you at the beginning of July, and you deposited the check on July 5. Here’s how this transaction would look for cash basis and accrual basis accounting. Cash basis accounting is a good option for small businesses or individuals, especially those who almost exclusively deal with cash.

In Quickbooks, you can choose either Cash or Accrual as your accounting method. You can also run reports that use either method, so you can compare how your finances look with each. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided. Businesses that start off using one accounting method and decide to change later can do so by filing IRS Form 3115 and getting approval from the IRS to change their accounting method (if they qualify). Please read our review for more information on QuickBooks Online and our ratings for other top accounting software. This approach can result in deferring tax liabilities, as income recognition may occur in a later tax period, potentially giving the business more time to use those funds for growth or other purposes.

Cash Basis Method

If the company receives an electric bill for $1,700, under the cash method, the amount is not recorded until the company actually pays the bill. However, under the accrual method, the $1,700 is recorded as an expense the day the company receives the bill. The key advantage of the cash method is its simplicity—it only accounts for cash paid or received. If your business does not fit into any of these categories (if you’re a publicly-traded company, for example), you may have to switch to the accrual accounting method.

Unlike accrual basis accounting, which records income and expenses as they occur regardless if payment has been received or not, cash basis net income only considers transactions where actual payment was made. Accrual basis accounting can give you a more accurate picture of your business’s financial health because it takes your business’s unpaid expenses and your customers’ unpaid invoices into account. That means it does a better job than cash basis accounting of matching expenses and revenue to the correct time period in which they were incurred. It also produces a more complete balance sheet that factors in accounts payable, accounts receivable, current assets such as inventory, fixed assets and liabilities like loans.