Legal Definitions - cash method of accounting

The cash method of accounting is a straightforward way for individuals and some businesses to track their financial transactions. It operates on a simple principle: income is recorded only when cash is actually received, and expenses are recorded only when cash is actually paid out.

This method focuses on the physical movement of money. For instance, if you send an invoice for services rendered, you don't record that income until the client's payment arrives in your bank account. Similarly, if you receive a bill for supplies, you don't record that expense until you actually send the payment to the supplier. This approach is often favored for its simplicity, as it directly reflects the money flowing in and out of an account, making it easier to manage for smaller operations.

Here are a few examples to illustrate how the cash method works:

• Freelance Writer: Imagine a freelance writer who completes an article for a client in late November but doesn't receive the payment until mid-December.

  Illustration: Under the cash method, the writer would record this income in December, not November, because that's when the money actually arrived in their bank account. The timing of the work completion is less relevant than the timing of the cash receipt.

• Small Landscaping Business: A small landscaping company purchases new equipment parts from a supplier in April and receives an invoice, but they don't pay the bill until May.

  Illustration: Using the cash method, the landscaping company would record the expense for the equipment parts in May, the month the payment was actually sent, rather than April when the parts were received or the invoice was issued. The expense is recognized when the cash leaves their account.

• Local Artisan: A local artisan sells a custom pottery piece to a customer. The customer pays a 50% deposit in September and the remaining 50% upon pickup in October.

  Illustration: With the cash method, the artisan would record the first 50% of the income in September when the deposit was received, and the remaining 50% in October when the final payment was made. The income is recognized precisely when the cash changes hands, regardless of when the sale was finalized or the item delivered.