Does Cash Accounting Mean You Receive Physical Cash?
No. How you receive funds has nothing to do with it. Cash accounting refers solely to when you record the money that comes into your business as income and work out how much tax you owe on it.
When Do You Record Income With The Cash Method?
You record income when the money is actually deposited to the bank account. Strictly, you should record it only when the transaction is completed, but many businesses mark in accounts receivable when they deposit the funds. This means that although you keep a record of how much clients owe you, it is not considered income and you do not pay tax on it yet.
Who Uses Cash Accounting?
The vast majority of small businesses and sole proprietors use cash accounting. Setting aside money to pay tax on income you have not yet received is beyond the scope of the cash flow of smaller entities (this is called accrual accounting). Cash accounting is also simpler to handle for sole proprietors who may handle their own bookkeeping.
Are There Tax Implications With The Cash Method?
Actually, the IRS much prefers that small business entities use the cash method of accounting. If you happen to be audited, you will have a much easier time of it if you are using cash accounting. There are no tax penalties associated with the method as the IRS does not consider it necessary for a business to declare income they have not received (and may not).
Are There Any Disadvantages To Cash Accounting?
The only disadvantage is that a pure cash accounting method does not record how much a company is owed. However, this can easily be worked around by recording accrual as well, and simply not marking it as income until the cash (check, money order, electronic transfer) is received.
Fishman, Stephen. “Cash vs. Accrual Accounting | Nolo.com.” Lawyers, Legal Forms, Law Books & Software, Free Information – Nolo. N.p., n.d. Web. 3 Nov. 2011. <http://www.nolo.com/legal-encyclopedia/cash-vs-accrual-accounting-29513.html>.
“Cash Method Accounting.” CompleteTax Income Tax Software Products. N.p., n.d. Web. 3 Nov. 2011. <http://taxguide.completetax.com/text/Q11_2206.asp>