What is a Cash-Basis Income Statement?

As a business owner, you can choose two different types of accounting methods. These are:

But which one is right for your business? Small businesses and startups will often find that cash-basis accounting is easier to implement (since it matches the bank statement), but that accrual-accounting is more accurate to truly reflect the performance of their company. Let’s explore the reasons why!

The Difference Between Accrual and Cash Basis Income Statements

Before we dive into why in most cases cash-basis is easier for small businesses, the differences really lie in the timing of when revenue and expenses are recognized.

Accrual-basis means that income is recognized and reported when earned vs. received and expenses when incurred; not necessarily when paid. This method helps create a more accurate picture of business operations. As an example, if March rent is owed the last day of February, accrual accounting would show the March rent in the March income statement, even if the rent was paid in February. This is more accurate because it matches the service period (the facility was used in March), but could be more confusing because the cash was debited from the bank account in February.

Cash-basis is where revenue is reported on the income statement only when the cash has been received, and expenses are only recorded when they have been paid out. Since these transactions aren’t recorded until the cash is received or paid, your company’s income won’t be taxed until it hits your bank account, while your expenses won’t be recorded until they are paid. This is the most common method for startups and small businesses. It is easy to match the Income Statement against your Bank Statement to determine when you paid vendors or received money from customers.

The Benefits of a Cash-Basis Income Statement

You are likely wondering why you wouldn’t use accrual-basis since it has the added benefit of gaining a clearer idea of your business operations. The overarching benefit of the cash-basis accounting method is that it is far simpler to use, making it much easier for small businesses to grasp and keep on top of finances.

Here are some other top benefits of a cash-basis income statement:

Inexpensive

Using the accrual method generally requires hiring a team of financial professionals to carry it out. Many small businesses can’t afford this luxury. Since cash-basis is much simpler to carry out, it, therefore, requires far fewer resources to do so.

Easier to Track

A cash-basis statement exists in the present. This means it only surveys when the transaction or money exchange has occurred. Because of this, it gives you visibility of the money you have on hand at that given moment, a crucial metric for any small business.

Ultimately, the cash-basis statement only deals with actual funds that go in and out. It doesn’t factor in any future expenses and income until the cash changes hands.

Advantageous for Taxation

Cash-basis gives you more control over the timing of transactions, which allows you to either speed up or slow down your revenue. This is a perfectly legal way to increase expenses and lower income to lower your tax liability. Because income isn’t recorded until it is received, there’s a lower probability of having to pay income tax on sales for which payment hasn’t yet been received.

Ease of Use

We’ve already mentioned the simplicity of using this method, but it’s worth talking about in more detail.

Getting to grips with company finances requires a steep learning curve. Unless your new business is finance-based, we assume that you don’t have the financial education or background to deal with them in the most effective way.

By using the cash-basis method, the learning curve is less steep and builds a solid foundation of knowledge for when you finally decide to switch to the accrual-basis method.

The Disadvantages of Cash-Basis Income Statements

With any way of doing something, there are cons that you need to be aware of. While cash-basis income statements have their advantages, they also have their limitations.

Prevents Accurate Forecasting

If you’re looking to make decisions on your financial future, you will find it a bit more difficult with this method. Because the cash-basis account statement only records daily finances, you don’t get a long-term picture of your financial health. The cash-basis statement is just a snapshot of a given period, meaning it doesn’t factor in accounts receivable and payable, future money coming in, and expenses going out.

Financial results of a given period could therefore look distorted and fail to show any liabilities, which further complicates any forecasting or planning. What this essentially means is that it may look like you have more money than you actually do, thus impacting financial decisions and growth.

Limits Investment

Any business that wants to expand and grow may find they’re restricted by their cash-basis account statement. Lenders typically refuse to give money to businesses that use this method because cash-basis accounting is not considered an actual representation of the financial situation.

Investors need the full picture before they will consider lending because they need to know their investment is low risk and can assure a favorable return.

You May Need to Switch Methods

Any company looking to grow will likely need to switch to the accrual-basis accounting method at some point. This is to gain the trust of lenders and investors, to be accepted for an audit (auditors do not accept the cash-basis method), and to accurately forecast and plan your financial future. Other reasons you may need to make the switch are if you offer the option to sell products or services on credit, business purchases and expenses are made on credit, or if you become a publicly traded company that will be listed on the exchange market.. Switching from cash-basis to accrual-basis involves:

Outsourcing Your Cash-Basis Accounting

While we thoroughly recommend gaining an understanding of how your company’s finances work, we also know that you cannot do every job that’s required in running a business. Outsourcing your day-to-day finances is one solution to make life easier and to ensure your financial records are always on time and accurate.

For example, EvolveCFO will provide you with a dedicated account manager who will oversee your daily bookkeeping and financial requirements, including cash-basis accounting. Everything will be provided to you using cloud-based software so you can easily keep track.

EvolveCFO also grows as you grow, with pricing plans to suit the level of service you require at every stage of your business journey. Essentially, you only pay for what you need, saving valuable resources while gaining vital expertise.

Get in Touch With EvolveCFO

If you would like to understand how cash-basis accounting can work for your business, talk to one of our experts today. We can also explain our other services and how they might benefit your business.

Why deal with the stress of finances when you can leave it to the professionals? You need to concentrate on making your business a success. That’s why EvolveCFO is on hand to provide you with financial peace of mind. Get in touch today to find out more.