Why do you need to select an accounting method?
What are different accounting methods?
You have taken the first steps in setting up your business but are not sure of the method that you should use to handle your accounts. Accounting is a necessary process that takes your business forward and helps you grow your business. Before running your business, you have to decide on a suitable method for your business.
What makes you think it is vital that you need to choose a suitable method?
The method that you choose for accounting affects your business in many ways. The main two methods are cash and accrual, so the method you choose has to suit the way you calculate your revenue for your company.
Both methods offer different financial reports that might influence your decisions for your company, depending on how you determine the financial position in a particular way. Therefore, you must choose the proper method to produce accurate financial reports.
Your chosen method will influence how you file taxes and claim tax deductions.
The cash and accrual methods report taxes at different periods depending on the revenue earning period. It would help to choose the best way for you during tax season.
When do you need to change an accounting method for your business?
When your business grows, you might want to change your accounting methods. Maybe you want to change from cash to accrual methods as you need to make some adjustments; also, you can sell on credit which helps to increase sales. You must also request a change in your accounting method with the IRS.
A business can mix the cash accounting method and accrual method to do the accounting for the company. It will have more accounts than the cash basis method because it uses the accrual method. The accrual method is the most complex, whereas the cash method is the easiest. It is also the modified cash basis accounting that uses double-entry bookkeeping.
What are the Pros and cons of the two methods?
As a small business owner, you may want to use the cash method because it is easy to maintain the records. Also, it is easy that you record your income only when you sell and receive the money you enter your purchase when you pay out the money.
Accrual accounting is more complex; you record your transaction as and when it takes and then create the ledger accounts like accounts receivable and accounts payable. Besides, you need to have an invoicing system. You need to set up the double-entry bookkeeping to check the long-term accounting records.
Cash method
If you plan to use the cash accounting method, also get to know the pros and cons of the cash business method.
It is also easy to do the accounting and learn to implement the system; it is a cost-effective method. For small businesses, it is advisable to use the cash method as it has several advantages over the other methods.
Feel comfortable using
Is it easy for small business owners to learn and implement this system for small business owners who do not have accounting knowledge?
There will be fewer accounts to deal with, so the time spent on accounting will be less than in the other system. So, the owner can spend more time looking after the business than accounting work.
Easy to know the cash balance
Finding the cash balance anytime you want is beneficial because it does not include future income or expenses. So you will know the cash in hand at any time.
It is a helpful method in tax calculations.
The calculation of taxes depends on the income and expenses received for a certain period. You can control your transactions during a period that allows you to increase your costs to reduce your tax obligation for a certain period.
Disadvantages of the cash basis method
Do not know the actual position of your finances.
It does not show the full explanation of your expenses as it does not consider the costs; it will make you think you have more money to spend and could get you in trouble. In the same way, if you have sold on credit for some reason, you do not have the record for it anywhere, and you will lose that money later.
Not all businesses can use the cash method.
If a business wants to sell goods or services on credit, it cannot use the cash method; also, if you use inventory to bring in income not possible to use the cash method.
Then if your income increases beyond a specific limit, you will not be able to use the cash method as your accounting process will not show clear accounting records.
You will find it difficult to change the method to implement the accrual method you need to implement;
- Records for payables
- Accounts receivables
- Subtract cash payments, cash receipts, and customer prepayments
Therefore, when transitioning your accounts books from cash to the accrual method, you must do extra work to bring everything in order.