Small business owners have to make numerous decisions, not the least of which is determining the best method to handle accounting. Typically, businesses use one of two principal accounting methods, known as cash method and accrual method a (also referred to as cash basis and accrual basis accounting respectively). IRS defines an accounting method as a set of rules used to determine when and how income and expenses are reported. Small businesses have to choose an accounting method when they first file their income tax return with Schedule C (Profit or Loss From Business) form.
While both methods are widely regarded as viable accounting options, each has its benefits and drawbacks. Further, the method you choose can have a serious effect on your cash flow and tax burden in the coming months/years. A leader in small business accounting, Accurants is happy to provide the following explanation of the cash and accrual methods so SMBs may be better equipped to make appropriate financial decisions.
Understanding the Cash Method
With cash basis accounting, businesses count their income at the time cash is received and record expenses at the time they are paid. Hence, they would not note income based on promissory notes or customer invoices.
Common among SMBs and individuals, this form of accounting allows new companies to declare more expenses upfront while recording profits down the line. It is also generally regarded as a simpler method of tracking expenses. According to some financial pros, though, this method can be misleading, as cash collection doesn’t always line up with the timing of sales. Hence, a company that uses the cash method might seem like it’s earning a profit when it’s actually losing money over time.
Understanding the Accrual Method
On the other hand, businesses that use accrual basis accounting record transactions at the time they occur, not when the money enters or exits their accounts. Under this system, companies note earnings at the time the sale occurs and expenses at the time the goods or services are received. Many accountants believe this system is more accurate because income and expenses are noted based on their causal relationships. Additionally, the system allows for simpler error checking, as assets always equal the sum of liabilities and equities for a given period.
However, businesses should be aware that it can be tough to track cash accurately with this method. As a result, SMBs who use accrual basis accounting might find themselves facing cash flow issues.
Choosing the Best Option for Your Small Business
The truth is that the accounting method you choose for your business can have a profound effect. Not only does it influence the way you bill clients and pay your own bills, but it also affects tax obligations and can even impact your ability to meet reporting rules for various regularity agencies. There are various factors that determine whether you must choose one method over the other. Factors such as, if your business stocks inventory of items that you will sell to public then IRS recommends that you must use the accrual method. Note that once you have indicated to use one method in your first income tax filing for your business, changing the accounting method requires IRS approval.
At Accurants, we offer a wide array of business accounting services to support companies of all sizes. We understand that it’s difficult for SMBs to handle all the tasks associated with accounting. To that end, we provide customers with a state-of-the-art software solution that handles invoicing, time tracking, expense tracking, project management, CRM, accounting, tax preparation, and more. Since choosing an accounting method is a very important decision for your business with far reaching implications, we recommend that you consult a certified accountant before filing the first tax return. You can trust us to be your partner in running a successful business that goes the distance.
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