When you start a new business, you have to make a decision regarding how you will approach your financial management. Two basic methods are available to you: cash basis or accrual basis. Although the two methods clash, there are also see some similarities.
Cash basis is an accounting method that counts income only after cash or a check is received and expenses are not counted until they have been paid. This method is the most popular accounting method among entrepreneurs and small businesses.
Accrual basis is an accounting method that counts income when orders are placed or services are requested, regardless of payment being received. Expenses are counted when your request for good or services is fulfilled.
If your business makes less than $5 million during your fiscal year, you have a choice between the cash and accrual methods. According to GAAP regulations, any business that is either publicly traded or produces over $25 million in sales revenue over a three-year period is required to use the accrual method.
So which do you choose?
One method isn’t necessarily better than the other, but each has its unique selling points. Here are a couple items to keep in mind when choosing your accounting method:
- Cash accounting is a simplified and more familiar process. It’s easy to track money as it moves in and out of your accounts. However, accural accounting can provide a more accurate financial picture. For example, if you have customers that don’t pay on time, you can get a better understanding of spending habits and plan for peak months of operation.
- If you’re looking to grow your business, you may want to consider accrual accounting from the start. If your business were to grow significantly and you were using the cash method, you’d have to update your practices to conform to GAAP regulations.
- Accrual accounting will set you up for a different tax process than cash accounting. Transactions that happen during the same fiscal year will look different between methods. For example, with the cash method, you won’t need to pay taxes on any money that has not yet been received. This is important for small businesses that may have cash flow issues.
If your business hasn’t grown to the point where you must use the accrual method, do some research before picking your how you handle your bookkeeping. Switching to the other method after making your first decision isn’t impossible, but is an extremely difficult and tedious undertaking. Talk to your accountant to get further insight about choosing your method. He or she might even have a preference as you begin your business relationship!
Need help deciding? We’d be happy to help you determine the right business accounting method for you. Contact us today!