Best Accounting Method for Your Business, Cash or Accumulation?

Cash or Accumulate: which method is right for you?

The basics of accounting are essential for every business. That’s why we developed a Accounting Guide. Through a series of articles, we highlight some of the key accounting concepts you need to know, when an accountant can help, and how to find and work with one.

In this installment of the series, we dive into an important question asked by many business owners: what is the best method for income recognition, cash, or accrual accounting?

Here’s what you need to know to make an informed decision.

What is the cash method of accounting?

Let’s start by defining the cash accounting method. This is the simplest way to record your earnings and simply means you record your earnings as you get paid. For example, if you bill a customer on April 30 and they pay you on May 15, you’ll post earnings on a later date. Cash accounting is also known as the calendar year method.

But what if you bill in November or December, but don’t receive payment until next year? If you use the cash method, you’ll record that income in the new calendar year, when you’re paid and reported on that year’s tax return. With this method, expenses are also deductible in the tax year you pay them.

One complication of the cash method of accounting is that it can distort your view of your books. If November and December are your busy seasons, you may not see that sales on your books until the new year. Thus, to an uninformed eye, it may appear that you are showing too little profit and negative cash flow, when in fact your business is doing well.

The cash method of accounting is not an option for everyone. List of IRS to exclude, to expel includes corporations (other than S Corporations) and a partnership with a corporation as a partner whose gross revenue exceeds $5 million.

What is the accrual method of accounting?

What to sell today? If you use the accrual method of accounting, you can book the sale as the sale happens, instead of waiting until you’re paid (as with the cash accounting method). For example, a company provides landscaping services to a customer on May 5 and bills it that day or even the next, with the understanding that the customer will pay within 15 days. Such revenue is recognized on the date the services are rendered.

While the accrual method provides a faster snapshot of your earnings than the cash method, it can leave you with more cash than you have available. This can be problematic if you are experiencing short-term cash flow gaps, so you will need to be diligent in maintaining and monitoring. cash flow forecast and cash flow statement for a more realistic picture of your cash situation.

Who can use the accrual method? However, anyone can mission business ‘apply accrual accounting if it has a total annual revenue of more than $10 million

Which is better for your business?

Cash accounting seems like an affordable way to go, especially for sole proprietors and LLCs that value simplicity in their accounting. One caveat: the cash method is not always suitable for today’s common complex business transactions. For example, most businesses operate on trade credit or net terms (30/60/90 days). The business may produce work as part of that agreement, long before it is billed. So 30 business days are done before the invoice is issued, then another 30/60/90 days before the invoice is paid.

If you use the cash method of accounting, revenue will be added to the books 60 days from the date of the original agreement (when payment is received). In the case of accrual accounting fans, revenue is calculated when the invoice is sent out, but before cash is available.

Fortunately, your accounting software (and your accounting) can provide accrual calculations, so you don’t need to understand the details of what’s flowing in when. And, if you’re waiting for payments from customers on trade credit, consider switching to a Fundbox line of credit, which can allow you to cash out short-term liquidity based on projected revenue. ​from unpaid bills..

When in doubt, seek the advice of an accountant, who can help you choose the right accounting method based on your financial needs, time, and preferences.

Stay tuned for the next installment in this series where we’ll discuss what an accountant can do to help your business and what they can’t. Missed part one? Get it here: 12 Accounting Terms Every Small Business Owner Should Know.

12 Accounting Terms Every Small Business Owner Should Know

Note: Fundbox and its affiliates do not provide tax, legal or accounting advice. This document has been prepared for informational purposes only, is not intended to provide, and should not be relied upon as tax, legal or accounting advice. You should consult with tax, legal and accounting advisors before engaging in any transaction.