Cash Accounting
Cash accounting records income only when money is actually received and expenses only when they are actually paid. It shows up as a simple record of cash and bank movements, with no receivables or payables. It matters because it is easy to run and mirrors the bank balance, but it can misstate profit — and Indian company law does not accept it for maintaining a company's books.
What Is Cash Accounting?
Cash accounting is the simplest way to keep books: a sale is income the day the customer pays, and a cost is an expense the day the business pays it. Nothing is recorded for a credit sale still to be collected or a bill still to be settled. Because it tracks only money in and money out, the accounts move exactly with the bank balance, which is why very small operators and some professionals find it convenient.
In India, cash accounting has a real but limited place. A Delhi freelancer or a tiny proprietorship may keep cash-basis records, and certain professionals are permitted a cash basis for income-tax purposes. But a company cannot: Section 128 of the Companies Act 2013 requires the accrual basis. And even where it is allowed, cash accounting can flatter or depress profit simply because of when payments happen to fall, so it suits only the simplest of businesses.
Key terms
- Accounts Payable — Unpaid supplier dues that cash accounting ignores.
- Accounts Receivable — Uncollected sales that cash accounting does not record.
- Cost of Goods Sold — The cost of sales, harder to match under a cash basis.
What Cash Accounting Includes and Excludes
Cash accounting counts only actual money movements, which is both its strength and its weakness when comparing businesses:
- Includes cash receipts — Income is recognised only when the money lands in cash or bank.
- Includes cash payments — Expenses are recognised only when the business actually pays them.
- Excludes receivables — Credit sales still to be collected do not appear as income or as an asset.
- Excludes payables and accruals — Bills incurred but unpaid are simply not recorded until settled.
- Why it distorts comparison — Because profit swings with payment timing, two similar firms can look very different, which is why lenders prefer accrual accounts.
How Cash Accounting Works in the Books
Cash accounting follows a short, literal path tied to the bank:
- 1Money is received
A customer payment hits cash or bank — the trigger to record income.
- 2Record the receipt as income
The receipt is booked as revenue on the date of payment, with no receivable created.
- 3Money is paid out
The business settles a bill; payment is the trigger to record the expense.
- 4Record the payment as expense
The outflow is booked as an expense on the payment date, with no payable recognised.
- 5Profit equals net cash
Period profit is simply receipts less payments, closely tracking the change in bank balance.
Cash Accounting: A Practical Example
| Particulars | Amount (INR) | Treatment |
|---|---|---|
| March sales, collected in April | 6,00,000 | No income in March (cash basis) |
| April collection of March sales | 6,00,000 | Income in April, when received |
| March supplier bill, paid March | 2,00,000 | Expense in March, when paid |
| March profit (cash basis) | (2,00,000) | Only the paid cost falls in March |
A Delhi freelance designer earns ₹6,00,000 in March but is paid in April, while paying a ₹2,00,000 software bill in March. On the cash basis, March shows only the ₹2,00,000 outflow and so a ₹2,00,000 loss, even though the month was actually profitable. April will then look unusually strong. This swing is exactly why cash accounting is unreliable for judging performance, and why accrual accounts are preferred.
Using it for a company: Keeping company books on cash basis breaches Section 128 → maintain accrual books for any company.
Cash Accounting Under Indian Accounting Rules
Section 128 of the Companies Act 2013 requires companies to keep books on the accrual basis, so cash accounting is not permitted for a company's statutory books. AS 1 treats accrual as a fundamental accounting assumption; a departure from it must be disclosed. Cash accounting survives mainly for very small non-corporate taxpayers and for certain professionals who are allowed a cash basis under the Income Tax Act 1961, but it never produces Schedule III-compliant company financial statements.
- Section 128, Companies Act 2013 — Requires accrual; cash basis is not valid for company books.
- AS 1 — Accrual is a fundamental assumption; any cash-basis departure must be disclosed.
- Income Tax Act 1961 — Permits a cash basis for some small taxpayers and professionals only.
Common Mistakes With Cash Accounting
Cash accounting misleads when it is used beyond the tiny businesses it suits:
- Using it for a company — Keeping company books on cash basis breaches Section 128 → maintain accrual books for any company.
- Judging performance on cash profit — Reading a cash-basis loss as a bad month ignores uncollected sales → look at accrual profit for the real picture.
- Ignoring unpaid bills — Not tracking payables leaves the owner blind to what is owed → keep a payables list even if books are cash-basis.
- Mismatching cost and sale — Paying for stock in one period and selling it in another distorts profit → match COGS to sales on an accrual basis.
Cash accounting records income only when money is actually received and expenses only when they are actually paid. It shows up as a simple record of cash and bank movements, with no receivables or payables. It matters because it is easy to run and mirrors the bank balance, but it can misstate profit — and Indian company law does not accept it for maintaining a company's books.
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Applicable framework: Companies Act 2013 (Section 128), AS 1, Income Tax Act 1961. For general information only, not professional advice. Verify the current position for your entity before acting.