Can You Have Accounts Receivable on Cash Basis?

Accounting methods dictate how businesses record financial transactions, influencing when income and expenses are recognized. These methods directly impact a company’s financial statements and tax obligations. This article explores the relationship between cash basis accounting and accounts receivable.

What is Cash Basis Accounting?

Cash basis accounting recognizes revenues only when cash is received, regardless of when goods or services were provided. Similarly, expenses are recorded only when cash is paid, irrespective of when the liability was incurred. For example, a freelance graphic designer on a cash basis records income only when a client’s payment clears their bank account, not when the invoice is sent. This method provides a straightforward view of a business’s cash flow, making it common for small businesses and sole proprietorships.

This method often aligns with income tax reporting for many small businesses. Under cash basis, a business reports income in the tax year it receives payment. Expenses are deductible in the tax year they are paid.

What are Accounts Receivable?

Accounts receivable (AR) represents money owed by customers for delivered goods or services. This arises when a business extends credit to its clients, allowing them to receive products or services immediately and pay at a later date. A common example is a consulting firm that completes a project for a client and then issues an invoice with payment terms, such as “Net 30.”

Accounts receivable is recorded as a current asset on a company’s balance sheet under the accrual method of accounting. It signifies a future cash inflow the business expects to collect. The existence of accounts receivable indicates that the business has earned revenue, even if the cash has not yet been received.

Reconciling Cash Basis and Accounts Receivable

From a formal accounting perspective, a business operating on a cash basis does not recognize “accounts receivable” as an asset on its financial statements. This is because revenue is only recorded when cash is received. Consequently, under cash basis, there is no accounting entry or recognition of money owed until the payment is in hand.

However, a cash-basis business can still track money owed internally for operational management. For instance, they might use spreadsheets or simple invoicing software to monitor outstanding invoices and follow up with clients on delayed payments. This internal tracking is for managing cash flow and collections; it does not constitute an accounts receivable entry on the business’s books or financial statements. The distinction is between a tool for managing operations and a recognized financial asset for reporting purposes.