Managing finances as a Canadian business owner can be a daunting task. With various accounting methods available, choosing the right one is crucial for keeping your business’s financial health on track. One method that stands out for its simplicity and straightforwardness is cash accounting.

In this guide, we’ll break down what cash accounting is, how it works, its benefits, and whether it’s the right choice for your business.

Whether you’re a solopreneur or a business owner, understanding how cash accounting works can make bookkeeping a lot easier. Let’s explore what cash accounting is and how it fits into your business.

Table of contents

• What is cash accounting?
• Who uses cash accounting in Canada?
• How does cash accounting work?
• Cash basis accounting examples
• Key benefits of cash accounting for small businesses
• Tax implications for Canadian businesses
• When to choose cash accounting over other methods
• Setting up cash accounting in QuickBooks
• FAQ

What is cash accounting?

Cash accounting is a simple accounting method where you record transactions only when money actually changes hands. This means income is recorded when you receive payments, and expenses are recorded when you pay bills or other financial obligations.

Essentially, it reflects the actual cash flow in and out of your business bank account.

Cash accounting vs. accrual

Cash accounting differs from accrual accounting, where you record income when it’s earned (even if you haven’t received the payment yet) and expenses when they’re incurred (regardless of whether you’ve paid them).

In cash accounting, you won’t see invoices or bills on your books until the payment is made. This makes it a popular choice among small businesses, freelancers, and solopreneurs who want a straightforward way to track their finances without dealing with complex accounting principles.

Imagine you’re a freelance graphic designer. You send an invoice to a client in January for $500 but don’t receive the payment until March. With cash accounting, you wouldn’t record that income until March, when the cash is in your hand.

The same goes for expenses. If you purchase new software in February but don’t pay for it until April, you record the expense in April.

Who uses cash accounting in Canada?

In Canada, small businesses often use cash accounting, particularly those that have straightforward operations. This includes solopreneurs, home-based businesses, freelancers, non-profit organizations, and other service-based businesses. Businesses that have minimal inventory or deal primarily in services may find cash accounting beneficial because of its simplicity.

Certain Canadian businesses, such as those in agriculture and fishing, are also allowed to use the cash method because their operations often depend on irregular income flows. However, not all businesses are eligible to use cash accounting.

For example, corporations (other than professional corporations), partnerships with members who aren’t individuals, and businesses with more complex financial structures may be required to use accrual accounting.

The Canada Revenue Agency (CRA) provides specific guidelines on which businesses can and cannot use cash accounting. It’s important to consult these guidelines before deciding what's best for your business.

For solopreneurs and smaller businesses with limited transactions, cash accounting is often the easiest and most efficient way to manage finances. It simplifies bookkeeping tasks and reduces the burden of tracking accounts receivable and accounts payable, making it a superb choice for those who don’t need the complexities of accrual accounting.

How does cash accounting work?

Cash accounting works by recognizing revenue and expenses only when cash is received or paid. Unlike accrual accounting, which records transactions when they are incurred (regardless of when cash changes hands), cash accounting provides a real-time view of your cash flow.

Here’s how it works in practice:

1. Income: You only record income when you physically receive payment. For example, if you invoice a client in January but don’t receive the payment until March, you record the income in March. This approach helps you track the cash that is truly available for your business at any time.
2. Expenses: Expenses are recorded when you actually pay them. If you receive a bill in April but don’t pay it until June, you would record the expense in June, not when the bill was received. This method ensures that your financial records reflect your real-time cash outflows.

A key benefit of this method is that it makes managing cash flow much simpler. Since you’re only tracking actual cash inflows and outflows, you get a more accurate picture of how much money is available to spend at any given moment. This can be especially helpful for businesses that operate on tight margins and need to closely monitor their cash position.

Cash basis accounting examples

An example of cash basis accounting is a small retail store that purchases products from a supplier. The store would recognize the expense only once the product payment has been made, rather than when they receive the goods.

Another example of cash basis accounting is a service-based business that provides services to its customers on credit terms. In this case, the income would only be recognized once payment has been received from the customer. 

Consider the following transactions for your business: 

1. You receive a $5,000 payment from a client for services on June 1.
2. You pay office rent of $1,200 on June 1.
3. You purchase office supplies worth $500 using cash on June 10.
4. You pay $3,000 in salaries to employees on June 15.
5. You collect $2,500 for a customer sale on July 1.

Here’s how the accounting journal entries would look in the accounting books:

Companies using the cash basis of accounting will have simpler financial statements than businesses using the accrual method. Here's a cash basis income statement:

Notice how there are no accounts receivable or accounts payable amounts on the following balance sheet. This is because revenue and expenses are only recorded when money changes hands.

And here's a sample cash flow statement from a company that uses cash based accounting. Note that the net income from the income statement carries over to the cash flow statement, and the cash at the end of the year on the cash flow statement matches the cash figure on the balance sheet.

Key benefits of cash accounting for small businesses

There are several reasons cash accounting is an attractive option for Canadian small businesses:

1. Simplified bookkeeping: Cash accounting eliminates the need to track accounts receivable and accounts payable. Instead, you only need to track the money that’s actually coming in and going out of your bank account. This can significantly reduce the complexity of your bookkeeping tasks and allow you to focus more on running your business.
2. Clear cash flow picture: Since cash accounting only records transactions when cash changes hands, it gives you a real-time view of your business’s cash flow. This can help you better manage your finances and make informed decisions about spending, saving, and investing in your business.
3. Fewer year-end adjustments: With cash accounting, there’s no need for complex year-end adjustments or reconciliation of accounts receivable and accounts payable. This makes tax time easier and can reduce the time you spend working with your accountant or bookkeeper.
4. Easier tax reporting: Small businesses using cash accounting may find it easier to report income for tax purposes, as income is only recorded when it’s received. This means you won’t have to pay taxes on income you haven’t yet received, which can be a major advantage for businesses that deal with delayed payments.

Tax implications for Canadian businesses

In Canada, certain types of small businesses can use cash accounting, but not all. The CRA has specific rules about which businesses are eligible to use this method. For example, professional corporations, businesses that maintain large inventories, and partnerships that include non-individual members are required to use accrual accounting.

However, small service-based businesses, freelancers, and solopreneurs are typically allowed to use cash accounting. If you fall into one of these categories, cash accounting can make tax time much simpler because you only report income you’ve actually received.

It’s important to note that even eligible businesses must follow certain rules when using the cash method. According to the CRA, farmers, fishers, and self-employed commissioned sales agents can use this method, but they must report income in the fiscal period in which it is received, whether it’s as cash, property, or services.

Prepaid expenses cannot be deducted until the fiscal period they apply to, ensuring that financial obligations are accurately accounted for. For more detailed information on eligibility and specific guidelines, the CRA recommends consulting Guide T4002, which covers self-employed business, professional, commission, farming, and fishing income.

Businesses with more complex financial structures, such as those with large inventories or multiple revenue streams, may be required to use accrual accounting for tax purposes. Always consult with a tax professional or review CRA guidelines to ensure you’re using the correct method for your business.

When to choose cash accounting over other methods

Cash accounting isn’t right for every business, but it can be a great fit for many small businesses, solopreneurs, and freelancers. Here are some situations where cash accounting may be the best choice:

• You run a service-based business: If you provide services rather than physical products, cash accounting can simplify your bookkeeping by focusing only on the cash that comes in and goes out.
• You don’t have large inventories: If your business doesn’t involve managing inventory, cash accounting is a straightforward way to track income and expenses without the complexity of accrual accounting.
• You prefer simplicity: Cash accounting is much simpler than accrual accounting, especially for businesses with limited transactions. If you want an easy way to manage your books and ensure you’re tracking cash flow accurately, cash accounting could be the right choice.

Businesses that manage large inventories, have more complex financial structures, or need to track accounts receivable and payable in detail may benefit more from accrual accounting. However, for many small businesses, cash accounting offers a simple, efficient way to manage finances.

While cash accounting can simplify things for your business, note that it's not as comprehensive as accrual-based accounting, and it's not useful for larger businesses. 

Setting up cash accounting in QuickBooks

QuickBooks makes it easy to set up cash accounting for your business. Whether you’re just starting out or switching from another accounting method, the platform offers tools that simplify cash-based bookkeeping.

To set up cash accounting in QuickBooks:

1. Log into your QuickBooks account: If you’re new to QuickBooks, you’ll first need to create an account and set up your company’s profile.
2. Navigate to your company’s settings: In your QuickBooks dashboard, go to your company’s settings by clicking on the gear icon in the top right corner. From there, select "Account and Settings."
3. Choose the cash method: Under the "Advanced" tab, you’ll find an option for "Accounting Method." Select "Cash" from the drop-down menu, and QuickBooks will automatically update your financial reports to reflect cash accounting.
4. Monitor your reports: QuickBooks allows you to generate real-time financial reports based on the cash method. This will help you track your income and expenses accurately and manage your cash flow more effectively.

Choosing the right accounting method is essential for managing your business’s finances effectively. Cash accounting offers a simple and intuitive way to track your income and expenses, especially for small businesses and solopreneurs.

If you think this method is right for your business, QuickBooks' cash accounting tools can make set-up and ongoing tracking easy. Explore QuickBooks solutions today to simplify your bookkeeping and take control of your business’s financial future.