In the United States, there are 2 methods for keeping your business books, and it is important to define which one you will use, as the IRS requests this information to receive and review your tax returns.
The difference between the cash method and the accrual method is the timeline when the business’ sales and purchases are posted to your accounts. Cash accounting registers income and expenses only when money changes hands, but accrual accounting registers revenue when earned and expenses when billed (but not paid). We’ll go into more detail about both methods.
The cash accounting method records income when cash is received and expenses when they are paid. This method does not record accounts payable or receivables.
Some small businesses decide to use this method because it is easy to determine when a transaction occurred, it is easy to maintain, and no receivables or payable records need to be kept.
This method is also very useful for determining how much cash the company has at any given time, this allows you to check your bank balance and understand the exact resources you have.
In this method of accounting, income and expenses are recorded when they occur, regardless of when the money changes hands.
One of the advantages of this method is that it provides a more realistic view of business revenues and expenses over a period of time, something cash accounting cannot provide.
The disadvantage of this type of accounting is that it fails to provide a clear view of the company’s cash flow, and this is one of the most important factors in determining the financial health of a business. This happens because, on paper, a business may seem very profitable, but in reality it may not have enough money in its bank accounts.
How to choose the right method for your business
If your business bills less than $25 million a year, you can choose any of the methods that benefit your business model the most. The cash method is mainly used by some small businesses, such as sole-proprietors and partnerships, for the simplicity of it.
The accrual accounting method is more widely used than the cash method, especially by established companies that generate substantial sales. When you need to submit your first tax return, you must specify to the IRS what type of accounting you will use. It is advisable to ask your accountant to specify which one is right for you.
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