Simply explained
- MBS QUICK FACTS:
- State-recognized since 1999
- Accreditation by the German Council of Science and Humanities
- Study Location: Munich
- Top Marks in numerous Rankings
Cash Method of Accounting is a simple procedure for determining profits that is mainly used by small businesses, the self-employed and freelancers. In contrast to double-entry bookkeeping, in which all business transactions must be recorded twice (debit and credit), the Cash Method of Accounting is based on a comparison of operating income and operating expenses within a financial year.
Here are the main features of the Cash Method of Accounting:
Cash Method of Accounting is therefore an efficient method for smaller companies to meet their tax obligations without having to deal with the complexity of double-entry bookkeeping.
The Cash Method of Accounting offers a number of advantages, especially for smaller companies, self-employed and freelancers. Here are the most important advantages.
Similar Financial Lexicon Topics:
Turnover
Turnover Tax
Liquidity
Taxable Income
The Cash Method of Accounting may be used by certain taxpayers who are not required to keep double-entry accounts. The Cash Method of Accounting offers a simple and practicable way of determining profits for smaller companies and the self-employed. Here are the most important groups that must or may use Cash Method of Accounting and who is obliged to keep double-entry accounts:
Category | Description | Must / May Cash Method of Accounting | Must Double-Entry Bookkeeping |
---|---|---|---|
Freelancers | Self-employed persons and freelancers who are not required to keep accounts | Mandatory Cash Method of Accounting | No |
Small businesses and freelancers | Entrepreneurs with an annual turnover of less than 600,000 euros and a profit of less than 60,000 euros | Must keep Cash Method of Accounting | No |
Sole traders and partnerships | Entrepreneurs who do not exceed the turnover and profit limits | Must Cash Method of Accounting | No |
Small businesses in accordance with Section 19 UStG (German Law) | Entrepreneurs with an annual turnover of less than EUR 22,000 and expected to be less than EUR 50,000 | Permitted Cash Method of Accounting | No |
Corporations (German GmbH, AG) | Corporations regardless of turnover or profit | No | Must keep double-entry accounts |
Large sole traders and partnerships | Entrepreneurs with an annual turnover of over 600,000 euros or a profit of over 60,000 euros | No | Must keep double-entry accounts |
The Cash Method of Accounting (Cash Method of Accounting) is used to determine profits for small businesses, freelancers and the self-employed who are not required to keep double-entry accounts. The profit is calculated by simply comparing income and expenditure. Here is the formula and the steps for the calculation:
Profit = Operating Income - Operating Expenses
Assume a small business owner has the following income and expenses in the financial year:
Revenue:
Expenditure:
Calculation of the profit:
In this example, the profit is € 17,000.
Important terms for the
Cash Method of Accounting
Term | Meaning |
---|---|
Cash Method of Accounting | A simple procedure for determining profit, in which the difference between income and expenditure is calculated. |
Income | All money received in the context of self-employment. |
Expenditure | All cash outflows in connection with the self-employed activity. |
Business Assets | All assets that are assigned to the business. |
Profit Calculation | The process of calculating taxable profit by comparing income and expenditure. |
Revenue Surplus | The difference between operating income and operating expenses, which represents the profit or loss. |
Operating Income | All income generated by operating activities. |
Operating Expenses | All expenses that are caused by operating activities and are deductible. |
Depreciation | Allocation of the acquisition or production costs of an asset over its useful life. |
Fixed Assets | Assets that serve the business in the long term and are not intended for sale. |
Current Assets | Assets that are intended for sale or are used in the business in the short term. |
Tax Free Amount | An amount that can be deducted from taxable income to reduce the tax burden. |
Business Tax | Taxes arising from business activities, e.g. sales tax. |
Sales Tax | Tax on the sale of products and services, which is usually paid to the tax office. |
Private Withdrawals | Withdrawals of money or material assets from business assets for private purposes. |
Private Assets | Assets that are not allocated to the business but to the private sphere. |
Taxable Profit | The profit determined by the Cash Method of Accounting, which is subject to income tax. |
Special Expenses | Certain expenses that are tax-deductible, such as insurance premiums or donations. |
Loss Carry-Back | Possibility of offsetting losses against profits from previous years. |
Loss Carryforward | Possibility of carrying forward losses to future years and offsetting them against future profits. |
This table provides an overview of the most important terms in connection with the Cash Method of Accounting and their meanings.
The Cash Method of Accounting form is a standardized document provided by the tax office. It must be submitted together with the income tax return. The form is divided into several sections, in which the various types of income and expenses must be recorded in detail. Here is an overview of the main sections and contents:
The following diagram shows the structure of the Cash Method of Accounting at a glance:
The following is a brief explanation of the Cash Method of Accounting structure.
The taxpayer's personal data must be entered in this section, for example a company (name, address, tax number).
All operating income is entered here, e.g. sales revenue, income from services, rental income.
This section is divided into different categories, e.g. material costs, personnel expenses, rent, depreciation, other operating expenses.
The determination of profit is a calculation of the profit as the difference between operating income and operating expenses.
Additional information can be entered here, e.g. details of reserves, tax deductions.
This table will help you to keep track of the individual steps and contents of the Cash Method of Accounting and to complete the form correctly.
Operating income | Sales revenue | Income from sales | € 30,000 |
---|---|---|---|
Revenue from services | Revenue from services | € 15,000 | |
Total revenue | Total income | Total revenue | € 45,000 |
Operating expenses | Material costs | Costs for material purchases | € 10,000 |
Rent | Rental costs for business premises | € 5,000 | |
Wages | Wage costs for employees | € 8,000 | |
Depreciation and amortization | Distribution of acquisition or production costs over the useful life | € 2,000 | |
Other operating expenses | Other operating expenses (e.g. office supplies, insurance) | € 3,000 | |
Total expenditure | Total of expenditure | € 28,000 | |
Profit calculation | Profit | Difference between total income and total expenditure (€ 45,000 - € 28,000) | € 17,000 |
There are some special features of the Cash Method of Accounting that must be taken into account when implementing and applying it. Here are the most important ones:
These special features of the Cash Method of Accounting ensure that the method is flexible and adapted to the needs of small and medium-sized companies. However, it is important to pay careful attention to these points in order to avoid mistakes and make the most of tax advantages.
This table helps to present the differences between Cash Method of Accounting and Balance Sheet Accounting clearly and concisely.
Criterion | Cash Method of Accounting | Accounting |
---|---|---|
Complexity | Simpler and less time-consuming | More complex and more time-consuming |
Recognition principle | Inflow-outflow principle | Accrual basis |
Presentation of results | Profit or loss through difference between income and expenditure | Balance sheet and income statement |
Legal basis and obligation | Section 4 (3) EStG German Law, for small companies and freelancers | German HGB, for larger companies and corporations |
Time of recognition | At the time of actual cash flow | Allocated to the financial year in which they were economically caused |
Changes in inventories | Are not recognized | Are recognized and reported in the balance sheet |
Scope of application | Small companies, self-employed and freelancers | Larger companies and corporations |
Example Revenue | Payment in January 2024 for service in December 2023 - recognition in 2024 | Invoice in December 2023, payment in January 2024 - recognition in 2023 |
Inventory accounts | Not required | Required, includes assets and liabilities |
Level of detail | Less detailed | Very detailed, includes all assets and liabilities |
With the Cash Method of Accounting, you can claim the input tax deduction in the period in which you received the invoice and actually paid the input tax.
With Cash Method of Accounting, you post income and expenses at the time of the actual cash flow, i.e. when the money enters or leaves your account.
The profit according to the Cash Method of Accounting is determined by deducting the operating expenses from the operating income.
You can switch from balance sheet to Cash Method of Accounting if you are no longer required to keep accounts and fall below the turnover and profit limits.
Whether a balance sheet or Cash Method of Accounting is better depends on the size and complexity of your business and your accounting requirements.
Our Bachelor's and Master's degree programs provide you with the relevant knowledge and skills you need for a successful career.