The problem with Cash Basis Accounting
 
      In Cash Basis accounting systems, expenses are not recorded on the financial statements until they have been paid. Because unpaid bills cannot be shown on the books, it is extremely difficult to accumulate Cash Reserves to pay them because of the current tax laws.
 
      In fact, Cash Basis accounting systems create a tax situation that, for some businesses, leads to bankruptcy while, at the same time, reports the company is making a profit.
 
      For example: Imagine your business has a project that spans several years; your income is received prior to completion of the job, but your major costs are paid after the job is completed. In other words, you receive money in a year prior to paying your expenses.
 
      If you save a portion of your receipts to pay your costs, at the end of the year your savings are shown as PROFIT because, in Cash Basis accounting, profit is, for the most part, the difference between the money received and the money spent. The effort is, therefore, to reduce your tax liability by reducing your profit - by spending the money.
 
      In cases where it is not feasible to pre-pay your major cost, the money is spent on other things and, because there is so much money available, your spending is out of control; no Cash Basis budget can set up appropriate spending levels on money received now and major costs that will not appear until a year or so later.
 
      Even if that could be done, it would decrease spending and make the tax problem worse. In the next year or so, when that major bill does arrive, there is little or no money left from the project to pay for it and receipts from new projects are used to pay the costs of the old ones.
 
      If there are many jobs and huge amounts of money flowing through the business, profits appear to be high and the business looks like a cash cow. But, as time goes by and the cash deficits accumulate year after year, major costs get harder and harder to pay.
 
      Should it then happen that business slows down and new jobs stop coming, the cash flow simply dries up leaving monumental unpaid bills. With the unpaid expenses not recorded, the Cash Basis Profit and Loss statement will report that you have made a profit.
 

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