Most businesses typically use one of two basic accounting
methods in their bookkeeping systems: cash basis and accrual basis.
While most businesses use the accrual basis, the most appropriate
method for your company depends on your sales volume, whether or
not you sell on credit, and your business structure. The cash
method is the most simple in that the books are kept based on the
actual flow of cash in and out of the business. Income is recorded
when it is received, and expenses are reported when they are
actually paid. The cash method is used by many sole proprietors and
businesses with no inventory.
From a tax standpoint, it is sometimes advantageous for a new
business to use the cash method of accounting. That way, recording
income can be put off until the next tax year, while expenses are
counted right away.
With the accrual method, income and expenses are recorded as
they occur, regardless of whether or not cash has actually changed
hands. An excellent example is a sale on credit. The sale is
entered into the books when the invoice is generated rather than
when the cash is collected. Likewise, an expense occurs when
materials are ordered or when a workday has been logged in by an
employee, not when the check is actually written. The downside of
this method is that you pay income taxes on revenue before
you've actually received it.
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Should you use the cash or accrual method? The accrual method is
required if your annual sales exceed $5 million and your venture is
structured as a corporation. In addition, businesses with inventory
must also use this method. It also is highly recommended for any
business that sells on credit, as it more accurately matches income
and expenses during a given time period. The cash method may be
appropriate for a small, cash-based business or a small service
company. You should consult your accountant when deciding on an
accounting method.
Excerpted from Start Your Own Business: The Only Start-Up
Book You'll Ever Need, by Rieva Lesonsky and the Staff of
Entrepreneur Magazine, © 1998 Entrepreneur Press