What is Cash Basis Accounting?
Cash basis accounting records revenue when cash is received and expenses when cash is paid. It ignores when the economic activity actually occurred.
Why Cash Basis Matters
Cash basis is simpler and shows exactly how much cash you have. For very early-stage startups or simple businesses, it may be sufficient. Many founders start with cash basis because it matches their bank statements intuitively.
However, cash basis creates distortions. A SaaS company that collects annual payments upfront would show huge revenue spikes followed by months of near-zero revenue, even though the business is stable.
When to Use Cash Basis
Cash basis works for simple businesses with immediate delivery and payment. Once you have recurring revenue, multi-period contracts, or investor reporting needs, you should switch to accrual.
Formula
Revenue = Cash received from customers
Expenses = Cash paid to vendors and employees
Example
Your ecommerce business in December:
- Sells $50K of products (customers pay with credit cards)
- Orders $30K inventory (pays supplier in January)
Under cash basis:
- Record $50K revenue when payment processor deposits funds
- Record $0 inventory expense until payment in January
Your December looks highly profitable, but January will show a big expense hit for inventory already sold.