When you are looking at starting a business, it is important to identify which accounting methods work best for you. There are two basic types: cash-basis accounting and accrual accounting. Understanding both accounting methods can help you choose which is right for your business.
With cash basis accounting, you record revenues when they are received and expenses when they are paid. It operates on gauging the literal moment that cash exchanges hands between you and your customers or those who you owe money. Typically, it’s the first type of accounting that a business owner will learn and implement.
It’s a simple approach. It uses a single-entry system that anybody can understand. You won’t need complex bookkeeping skills to master this form of accounting and as a result, it is great for businesses that are just starting out on their path to success.
It’s limitation to cash payments. As a result, larger companies or those who have dozens of transactions in a single day often struggle with this kind of accounting. And for those who use digital and card-based transaction methods, it becomes hard to manage.
Accrual accounting tracks transactions when they are due, paid or when money is owed. This might seem like a minor difference, but it is an important one. It records everything based on connections with specific transaction types, rather than just cash exchange.
It creates an accurate understanding of your business’ flow of money through a detailed look at your accounts. It also allows you to track check, credit and debit cards, and digital purchases. This method focuses on when money should exchange hands, rather than when it actually does.
It is a more complex form, requiring real training methods to master. In fact, it might even require attending a few classes. The biggest challenge with accrual is that it requires a little guesswork. After all, you are operating based on when money should exchange hands, rather than the moment when it does.
When you first start your business and report your first tax return, you have to specify if you are using either cash or accrual accounting methods. So when should you choose cash and when should you choose accrual? Well, it depends on several factors.
Typically, accrual is chosen as an accounting method based on when you receive your income and when you pay your bills. With accrual, you can defer when you receive payments and record your expenses when they are due.
In this way, you can ensure that you don’t end up with a difficult tax return later as you wait for your revenue to trickle into your business. It is also a useful accounting method if you need to keep track of income that has not been returned to your business, such as a check or a digital payment that has yet to clear.
So make sure to carefully consider these options before making a decision as it can heavily affect your business in a variety of ways, and make it more difficult to manage your finances. Consult a trusted bookkeeper or accountant for assistance in determining which method is the right one for your organization.