Cash flow accounting is a simple accounting method used by some businesses. Income and expenses are recorded as money comes in and goes out of the business, allowing management to see how much money is available at any given time. The simplicity of cash flow accounting is one of its largest benefits, but the accounting method has its disadvantages as well.
Lack of Tracking
Payments to the business are recorded as they come in, as are payments out of the business. The dates and times of these transactions are not recorded, however, making it very difficult to track down specific payments if errors are suspected. Likewise, the lack of tracking makes it impossible to connect specific payments with items of inventory or services that are rendered by contractors or other third parties. Being unable to track these payments can be a major disadvantage if accounting errors occur.
Offset Payment Problems
Cash flow accounting lacks dedicated departments for accounts receivable and accounts payable, making it difficult to keep track of money owed to the business as well as money that the business owes. This becomes a larger concern when shipments and deliveries are billed separately from the actual delivery of goods or when the business performs services but does not receive immediate payment; unpaid debts and payments due can become lost or delayed, resulting in problems between the business and its suppliers or customers.
Lack of Oversight
Because cash flow accounting doesn't track the flow of money within a business, accounting errors can go unnoticed until they cause cash flow problems. Without the oversight provided by in-depth accounting and the separation of accounts payable and accounts receivable, financial reports can be produced which contain significant errors that simply haven't been noticed within the fluctuations of cash flow. This can result in financial reports and projections that are inaccurate or in some cases are significantly overstated.
Partial Payment Recording
When partial payments are made or received they aren't recorded as being only part of a larger payment. At first glance, a partial payment may appear as a full payment on a balance sheet and lead business managers to think that all money due to the business or all money owed has been paid. This can result in accounting errors and the unintentional underpayment of debts. Confusion can also arise if multiple partial payments are mistaken for full payments, leading to unnecessary audits and wasted time trying to find the source of the error.
Cash flow accounting does not accurately reflect the expenses required to generate income, making it difficult to determine how profitable a business actually is. Large purchases that may assist in operating the business for months or years will be matched only with the income of the period in which the purchase was made, making that period seem significantly less profitable. Likewise, significant expenses required to make money might not be associated with the period of higher income they generate if the income occurs within a different accounting period.