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Cash Basis vs. Accuals Basis

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Topic: Cash basis versus Accrual basis of accounting
The cash basis of accounting, sometimes called cash accounting, is still used by some small companies whose business activity is uniform throughout the year--receiving and disbursing roughly the same amount of cash each month. Many individuals also use cash accounting.( Edmonds, McNair, Milam, and Olds, Fundamental Financial Accounting Concepts, 4th edition, McGraw-Hill Irwin, 2002)
In the cash basis of accounting, the business records are "cash in" (deposits to the bank account) called cash receipts, and "cash out" (checks) called cash disbursements. Cash receipts - Cash disbursement = Cash flow. Each month's cash flow is added to the preceding month's cash balance yielding the current month’s cash balance.
The cash basis of accounting is more likely to be used by service businesses than by retail or manufacturing businesses. Service businesses usually do not need equipment and can sell a service they perform with nothing more than their own hands and minds. Think of people who are lawyers, writers, public relations and advertising personnel, and accountants.
There are two problems with cash accounting: 1) A business has difficulty in determining if it is earning a profit unless it is a small service business that does not own any property or equipment and does not have a number of contracts in progress, and 2) A business cannot keep track of any asset except cash. The cash basis of accounting does a poor job of matching revenues and expenses and does not spread the cost of significant operating assets over their useful life.
Unless a business is a small service company, it cannot tell if it is earning a profit if it uses cash accounting. There are two reasons. The first reason is that cash receipts and disbursements related to the same business activity do not always fall in the same month. For…...

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