Most businesses typically use one of two basic accountingmethods in their bookkeeping systems: cash basis or accrual basis.While most businesses use the accrual basis, the most appropriatemethod for your company depends on your sales volume, whether ornot you sell on credit and your business structure.
The cash method is the most simple in that the books are keptbased on the actual flow of cash in and out of the business. Incomeis recorded when it’s received, and expenses are reported whenthey’re actually paid. The cash method is used by many soleproprietors and businesses with no inventory. From a taxstandpoint, it is sometimes advantageous for a new business to usethe cash method of accounting. That way, recording income can beput off until the next tax year, while expenses are counted rightaway.
With the accrual method, income and expenses are recorded asthey occur, regardless of whether or not cash has actually changedhands. An excellent example is a sale on credit. The sale isentered into the books when the invoice is generated rather thanwhen the cash is collected. Likewise, an expense occurs whenmaterials are ordered or when a workday has been logged in by anemployee, not when the check is actually written. The downside ofthis method is that you pay income taxes on revenue before you’veactually received it.
Should you use the cash or accrual method in your business? Theaccrual method is required if your business’s annual sales exceed$5 million and your venture is structured as a corporation. Inaddition, businesses with inventory must also use the accrualmethod. It’s also highly recommended for any business that sells oncredit, as it more accurately matches income and expenses during agiven time period.
The cash method may be appropriate for a small, cash-basedbusiness or a small service company. You should consult youraccountant when deciding on an accounting method.
