Which accounting method is best for
your business?
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 system 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 while 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.
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
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
