What is a Cash Cost?
A cash cost is a cost that is paid immediately in cash or an equivalent like a check or a money order. This is in contrast with costs paid on credit, either through a credit agreement with a vendor or the use of a credit card or line of credit to cover expenses. Businesses that use a cash accounting method record cash costs as soon as they are incurred and only record credit costs when cash is paid to settle credit accounts. This accounting method can pose some challenges, leading many business to prefer to use accrual accounting to monitor their account activities.
Essentially, a cash cost is any cost that is paid up front in immediately available funds. The funds for such costs are taken directly from a company's accounts, rather than being extended on credit and repaid later. There are many types of transactions where payments in cash are required for safety and security and these would all be recorded as cash costs for bookkeeping purposes. Some people and businesses operate entirely in cash for convenience or other reasons and thus only have cash costs.
In cash accounting, whenever a cash payment is made to settle a cash cost, it is recorded in the general ledger, along with information about the transaction. One problem with this method is that there is no mechanism for recording credit transactions, and thus the general ledger does not provide an accurate reflection of business conditions. A business could have outstanding credit transactions that are not recorded, creating a misleading depiction of its financial health.
A cash cost can include accounts that are settled immediately, ongoing expenses paid in cash, many utilities, and so forth. In accrual accounting methods, in addition to recording cash costs as they are incurred, accountants also note credit transactions. By recording these transactions when they occur, even if no money has changed yet, the business is able to keep better track of its financial situation, and to generate a more honest picture of its finances for concerned parties.
Approaches to accounting methods vary, depending on the business. Many have turned away from cash cost accounting to accrual accounting because they find the accrual method more accurate and helpful for their needs. Accountants can provide specific advice on accounting methods and the option that might be most appropriate for a given business. Once an accounting method is selected, it must be consistently applied and used to reduce the risk of confusion, inaccurate financial statements, and other problems.
@MrMoody - Yeah, I agree. You need to calculate the true loan cost with any loan you take to finance your business, to know if you are really getting a good deal.
Corporations report on their outstanding loans in their financial statements and loans are one of those figures that help to reflect on the financial state of the business, in addition to the accounting method use, like the article says.
On that point, I think a really savvy investor looking at the financial statement should understand the meaning of the different accounting methods. It’s quite possible that a set of figures reported using an accrual method would look different if reported through some other method, and lead the investor to a different conclusion about the company’s financial picture.
@allenJo - I envy you. That’s a great way to fund a business. Imagine not having to approach a bank for loans on your business idea, or go through the hassle of coming up with a business loan proposal.
We, on the other hand, operate like most businesses do – using a mix of cash and credit. I don’t work in the accounting department so I don’t know when we use which of the two, but I would bet that cash is used for everyday items like office supplies, and credit is used on equipment like infrastructure or other outlays of capital.
The key to winning with credit however is to get the lowest possible interest rates on the loan so that you can help keep the capital cost down as low as possible and pay it back quickly.
Our business operates entirely on a cash basis, which is unique in itself. We have never funded the assets of our business through loans, since we are a software company and we are basically working with intellectual capital.
The entire base of the source code is the engine of the business, and that was created, at least in part, as an outgrowth of an earlier business operation where the software product was developed and then sold to the market.
As a result, the company made money almost from the start, and used the money from its software sales to fund the ongoing costs of the business, and recruited sales people to make more sales. To me, this is the best way to operate any business although I understand that it’s certainly not the only way.
The only loan we have is for a new building we bought. Everything else is cash.
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