Cash or Accrual Method for Your Business

You may recall reading about the value of getting your business organized, but not all types of bookkeeping are the same.  Whether you choose to operate on the cash method or the accrual method, that decision can have a significant impact on your business, especially when it comes to tax time.

Under the cash method of accounting, income is recorded when you receive payment for a sale or transaction, while expenses are recorded only when they are paid.  So for example, if you purchase a company car for your business in December 2011, but don’t pay for it until February 2012, the expense would be recorded in February, not December, even though the car was in use starting from the date of purchase.  Similarly, if a client signs a contract in June but doesn’t make a payment until August, the income would be recorded in August.

Conversely, with the accrual method, income is recorded when a sale is made or a transaction completed, and expenses are recorded when you receive a good or service.  Using the same examples as above, the expense of the company car would be recorded in December 2011 and the income from the client’s contract would be recorded in June.

The difference between these two methods becomes extremely important when it’s time to file business taxes.  If you operate under the cash method, the expense of the company car would not go on your 2011 taxes because it was not paid until tax year 2012.  If, however, you use the accrual method, the expense is recorded for the tax year in which it was incurred (2011).

The accrual method is more popular, as well as required by the IRS for businesses that have sales of more than $5 million per year.  Understanding these two methods of accounting will help you make the best decision for your business.  Each one has its benefits and drawbacks, so be sure to consult with a tax professional!


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