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Cash Accounting: How it Works & Should You Use It? - YouTube
Channel: Accounting Stuff
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in this video you'll learn what a cash
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basis of accounting is why loads of
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people use it and what the pros and cons
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are
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[Music]
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hey I'm James and welcome back to
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accounting stuff the channel dedicated
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to all things accounting in today's
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video we're continuing our series on
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accounting basics today's topic is the
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cash basis of accounting which is a
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handy way of doing your books if you're
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a small business owner if you haven't
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heard of it already you may in fact
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already be using it don't forget to
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stick around to the end of this video
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because I'm going to be sharing all of
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the pros and cons of this accounting
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system and I'm starting right now the
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cash basis of accounting is a method of
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recording financial transactions under
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this method transactions are only
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recorded once cash changes hands we
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record revenue only when cash is
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received and we record expenses only
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when cash is paid out let me elaborate
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on this with a simple example imagine
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you've got a baking business and a
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customer places an order for a birthday
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cake the ingredients for this cake cost
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you $10 to buy and you are selling it at
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a 150 percent markup on cost so the
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customer pays you $25 you've got two
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transactions to record first you need to
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record the expense which in this case is
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the cost of buying the ingredients for
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the cake
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you debit your expenses by $10 to
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increase them and you credit your cash
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by $10 to reduce your cash balance you
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then need to recognize your revenue
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which is the $25 that the customer pays
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you you debit your cash by $25 to
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increase it and you credit your revenue
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by $25 to increase it as well if you're
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new to debits and credits or you'd like
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a refresher I recommend that you check
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out this video now I want you to
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consider two scenarios the first is that
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you buy the ingredients for your cake
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you bake it and you sell it all the same
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day on the 25th of October the customer
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pays you in cash under the cash basis of
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accounting transactions are recorded
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when money changes hands so in this case
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you've record your expense and your
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revenue on the same day the 25th of
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October the second scenario is the same
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as the first except this time the
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customer pays on account your business
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has seven-day payment terms so you
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receive the cash a week after you baked
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and hand it over the cake to the
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customer under the cash basis of
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accounting you record your expense the
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day that you bought the ingredients for
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your cake and you recognize your revenue
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the following week on the first of
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November because that's when you
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received the cash from the customer so
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what are the pros of using this method
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for one it's a great way to record
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transactions small businesses that deal
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and operate mainly in cash it's simple
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and easy to understand so your business
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doesn't necessarily need to hire an
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accountant or someone that understands
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more complex accounting methods that
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makes it cheap to maintain and you might
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be able to get away without paying for
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more pricey accounting software and
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finally many countries accept this
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method of accounting for tax purposes so
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long as your earnings are below a
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certain threshold so this could be a
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viable option for you now you might be
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thinking wow this sounds amazing
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why doesn't everyone do it well in
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reality most businesses are much too
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complex to use this method of accounting
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when you cash account you don't have an
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accurate way of recording your profits
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so there can be huge fluctuations in
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your results this is caused by recording
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income and expenses in separate
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accounting periods if we go back to that
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second scenario we can see that we
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recorded the expense in October and the
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revenue in November so the October
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accounting period would show a loss of
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$10 and the November accounting period
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would show a profit of $25 it would make
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much more sense to show a profit of $15
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in October because that's when the work
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was done in addition to this you have no
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way of knowing your financial position
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because you aren't recording your
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payables and receivables finally and
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this can be a clincher the cash basis of
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accounting isn't allowed under GAAP or
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IFRS so if you follow either of these
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principles or standards then no dice
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so the cash basis of accounting can be a
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great way to record transactions if
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you've got a small business that relies
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solely on cash however if your business
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has payables and receivables this method
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probably won't work well for you because
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timing differences between cash in and
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cash out meaning you don't have a
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reliable way of recording your profit if
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that's you then you'll need to use the
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accrual basis of accounting instead to
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match up those revenues and expenses
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I'll take you through this method in the
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next episode of accounting staff thank
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you for watching today's video if you
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found it useful you can help support the
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channel by giving it a like it really
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makes a difference subscribe if you want
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to see more and hit that little bell so
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you don't miss out in the next one as
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always if there are any topics you'd
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like me to cover let me know in the
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comments below I love hearing what you
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guys have to say and I always do my best
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to respond had a great time learning
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with you today until next time
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[Music]
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