What Accounting method suits your business?
There are two methods available for a small business today. These two methods are cash and accrual methods. These methods arrive at the profit by creating an income and expenditure account. The sales and purchase figures are transferred into this account to calculate the benefit for your small business.
Cash
This method is used when selling your products for immediate payment by cash. Then it is accounted as a sale for your accounting records. The same principle applies to purchases when you pay with money recorded as a purchase in your documents.
Accrual method.
You are selling your products on credit and invoice this customer asking for payment on or before an agreed date. This particular customer becomes your debtor. Two types of entries will be recorded in the books; one is credited as a sale to show income. And the other one will be debited as a debtor to show your receivable income. The amount will be used to set off the debtor’s account when payment is received. If the customer fails to pay within a specified period, the customer will remain a debtor in your records.
The main differenc
e between the two types is the period. It must be written off if you fail to recover the money for your sale. The transactions you recorded in your books need further adjustment to show the figures. The accounting for cash method marked whether it is a sale or purchase only on the date when the cash is received or paid.
Under the accrual method, the sale or purchases are recorded as and when the order is placed, and the product is received.
Any business can use either method for their business, but there are some advantages and disadvantages to both processes.
Accrual method
The accounting records are in order as you will have the invoicing system, and you could quickly arrive at the sales figure. The most significant disadvantage is if you have the accurate sales figure but will not have the same number in cash flow. Therefore you could face serious cash flow problems. To solve that problem, you control your invoicing policy and get the customers to pay on time.
Cash method.
You are selling your goods in cash and not having the cash flow problem unless your sales go down. But on the accounting side, you will not know your profit if the records are improperly maintained. You will also jeopardize your business, as dealing with cash can sometimes be dangerous. It could have a long-term effect on the profitability of your business. And more accurate recording is needed to ensure the difference between the actual cash sales and other receipts. The money you receive from your debtors must account for in the books separately.
Claiming Tax Deductions
Your business can get affected by the method you choose. It will involve the tax year and consider the income and expenses in that particular year.
You cannot claim tax deductions if you incur expenses in one year and did not pay that year. It applies to the cash method; you can claim the tax deductions the following year. It is different in the accrual method because you record the transaction as and when you enter. Therefore you can claim the tax deductions in the same year regardless of the money received.
.