When you’re running a small business, it may seem like deciding between cash and accrual accounting is just one more thing on the long list of things you need to get done. But the fact of the matter is the decision on which accounting method you’re going to use makes a difference in something as simple as how you do your taxes and can have long-lasting effects beyond the end of the year.
The Difference Between Cash and Accrual Accounting
The cash method of accounting is the most common choice for small business owners. Under the cash method, you don’t count income until you have the cash or the check in hand and you don’t count expenses until the money leaves your account. In comparison, under the accrual method of accounting, you record transactions when they happen, no matter when the money actually changes hands. The cash method tends to more popular because it’s easier for many businesses to keep track of. But if there’s a lengthy delay between when you do work and when you receive payment, some issues can occur.
There are some situations in which your business absolutely must use the accrual method. If you have sales of more than $5 million per year or your business maintains an inventory of items you sell to the public and your gross receipts total more than $1 million per year, you’re required to use the accrual method.
Paul Miller, a professional juggler who just happens to have a degree in accounting, chose the accrual method in an industry — entertainment — that tends more towards the cash method. His choice was based on the fact that it’s easier to tell where your business’ finances actually are with accrual accounting, rather than just knowing what cash you have on hand. "I selected the accrual method for more accurate reporting. Many of my receivables are paid net 30, net 60 and sales as a whole are very dependent on the month of the year. I will earn $20-30,000 from library and camp work in August and much of it won’t be paid until September. Most of this income in September will be from school and after-school programs. By using the accrual method, I can get an accurate picture of how much I earned each month and from what sources," says Miller.
Using Accounting to Manage Taxes
One of the biggest changes a choice in accounting methods can create is how you handle tax deductions. Under the cash method, if you make a purchase in 2010 but don’t send payment until 2011, you won’t be able to deduct that expense until 2011. Under the accrual method, however, you would be able to claim the deduction in 2010. That may sound like a subtle difference, but depending on your business’ expenses and income, it can be quite complex.
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