How does an accrual basis give better income?
An accrual basis gives more income because you offer customers credits to buy the goods from you. When you sell, you will have more sales because people like to buy on credit as they have time to pay.
Of course, when you write your sales records, the income has increased, showing that it offers a more significant profit in your profit and loss accounts. But we have to consider the reality: do we have enough cash in our hands? The answer is no; the consequence is that you will face a cash flow problem and run out of working capital. So, you might struggle to run your business and start looking for outside funds to cover the difference in your cash flow. That shows the difference between cash & profit, so the entrepreneurs will have to consider that without thinking that their business is doing well.
The accrual basis means you sell products on credit. It is my question for you. Do you think all your credit customers will make payments on time? What will you do if some of them do not pay you the money they owe you? My answer is that you have put your small business in big trouble. That results in facing two immediate issues: one, you will face cash flow problems, and second, your profit will go down because you have to write off some of the sales from your income account. Then your business might show a loss that will have another effect; if you want to get a loan from a bank, they will refuse after looking at your profit & loss account.
Therefore, credit sales will improve sales, and you need proper internal control to prevent losing money. The facts that you have to consider before starting selling on credit.
- Implement invoice system
- Choose the customer to give credit to.
- Invoice immediately.
- Send reminders and follow it up.
- Do you have a contingency plan to meet the shortfall in funds?
The best option to have more sales in a small business is to watch the profit margin when setting the price. When you notice the sales are declining, start offering discounts and selling in cash. Then the customers will move on to you to get the deal instead of going to the competitors.
Pricing of a product is a crucial factor; when you sell goods in cash, it has to match your costs and make a little profit if you want to have a higher sale. But accrual basis credit possibilities have a higher deal but consider the risk involved, which I have mentioned above in this article.
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 will 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, regardless of the money received, you will claim the tax deductions in the same year.