Cash-Basis Accounting

Cash-basis accounting works like a personal bank statement. Money in is income, money out is an expense, and the timing of the cash decides the period in which each item is recorded.

If a freelancer finishes a 3,000 job in December but is paid in January, the 3,000 is recorded as January income. If they buy software in December but pay for it in January, the cost is a January expense.

The method is simple and shows clearly how much cash the business has. It is common for small businesses, sole traders and individuals, and some tax systems allow very small businesses to use it.

Its weakness is that it can give a misleading picture of performance. A business could look very profitable in a month when several customers happened to pay old invoices, and unprofitable in a month when it paid a large annual bill. Because income and expenses are not matched to when they were earned or incurred, larger businesses and most companies reporting to investors must use accrual accounting instead.