Definition: Cash Accounting
What is Cash Accounting?
Cash accounting uses regular bookkeeping journal entries to record a business's financial transactions. Cash accounting is unique in that it calculates net profit as all cash-collected income minus all cash-paid expenses. Income from credit (buy now, pay later) purchases and sales are excluded. For example, if a business purchased $1,000 of supplies on credit (buy now, pay later) from a wholesaler, the business' cash accounting net profit calculation would NOT include the $1,000 unpaid expense even though the business committed to the purchase. The effect of the credit purchase does NOT lower the business's cash accounting net profit by $1,000 until the business actually pays for the supplies.
The same is true for income in cash accounting. If a business sells a customer $1,000 of product on credit (buy now, pay later), the $1,000 of income from the sale will be excluded in the cash accounting net profit calculation because the customer did not yet pay for their purchase. The effect of the sale will NOT increase the cash accounting net profit by $1,000 until the customer actually pays their debt.
Cash Accounting Net Profit = Cash Income - Cash Expenses
This is why cash accounting is commonly referred to as cash basis accounting. The term "basis" refers to net profit being calculated on an cash accounting basis. The basis calculation does not relate to how the journal entries are recorded, as all entries in accounting are recorded the same way. It is the interpretation of the entries that changes according to basis.
You can think of cash accounting as a method of calculating net profit based solely on cash flow. Since credit purchases are ignored in a cash accounting net profit calculation, a cash accounting net profit calculation is nicknamed "cash profits". the nickname references profits as being actual cash profits as opposed to potential cash profits. Potential profits become cash profits when income is collected and debts paid with cash. Cash profits are exceptionally important because they are essential to running a business over time.
The opposite method to cash accounting is the accrual accounting. Accrual accounting calculates net profit based on all income minus all expenses independent of payment. Learn more about accrual accounting.
If you are interested in quickly learning the basics of accounting and bookkeeping, try our online high school college accounting prep course. It's a perfect fit for students and business owners who want a greater understanding their bookkeeping so that they can speak confidently with their bookkeeper and accountant.
The same is true for income in cash accounting. If a business sells a customer $1,000 of product on credit (buy now, pay later), the $1,000 of income from the sale will be excluded in the cash accounting net profit calculation because the customer did not yet pay for their purchase. The effect of the sale will NOT increase the cash accounting net profit by $1,000 until the customer actually pays their debt.
Cash Accounting Net Profit = Cash Income - Cash Expenses
This is why cash accounting is commonly referred to as cash basis accounting. The term "basis" refers to net profit being calculated on an cash accounting basis. The basis calculation does not relate to how the journal entries are recorded, as all entries in accounting are recorded the same way. It is the interpretation of the entries that changes according to basis.
You can think of cash accounting as a method of calculating net profit based solely on cash flow. Since credit purchases are ignored in a cash accounting net profit calculation, a cash accounting net profit calculation is nicknamed "cash profits". the nickname references profits as being actual cash profits as opposed to potential cash profits. Potential profits become cash profits when income is collected and debts paid with cash. Cash profits are exceptionally important because they are essential to running a business over time.
The opposite method to cash accounting is the accrual accounting. Accrual accounting calculates net profit based on all income minus all expenses independent of payment. Learn more about accrual accounting.
If you are interested in quickly learning the basics of accounting and bookkeeping, try our online high school college accounting prep course. It's a perfect fit for students and business owners who want a greater understanding their bookkeeping so that they can speak confidently with their bookkeeper and accountant.
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The Addictive Accounting training course has a purpose:
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If you are a student who is planning on studying accounting, or a student who is struggling to learn the concepts, this course is for you. If you want an A grade, take this prep course! If you are business owner who wants to fully understand their personal bookkeeping, this course is also for you.
To help you quickly master the fundamentals of bookkeeping and accounting!
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If you are a student who is planning on studying accounting, or a student who is struggling to learn the concepts, this course is for you. If you want an A grade, take this prep course! If you are business owner who wants to fully understand their personal bookkeeping, this course is also for you.
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