Cash Basis

A major accounting method that recognizes revenues and expenses at the time physical cash is actually received or paid out. This contrasts to the other major accounting method, accrual accounting, which requires income to be recognized in a company's books at the time the revenue is earned (but not necessarily received) and records expenses when liabilities are incurred (but not necessarily paid for).

When transactions are recorded on a cash basis, they affect a company's books only once a completed exchange of value has occurred; therefore, cash basis accounting is less accurate than accrual accounting in the short term.

For example, let's say a construction company secures a major contract in a given year, but will only be paid for its efforts upon completion of the project. Using cash basis accounting, the company will only be able to recognize the revenue from its project at its completion, while it will record the project's expenses as they are being paid out. If the project's time span is greater than one year, the company's income statements will be misleading: the company will incur large losses one year and then great gains the next.

Cash basis accounting is simpler and cheaper to perform than accrual accounting, but it can make obtaining financing more difficult due to its inaccuracy.