Cash Basis Accounting vs Accrual Basis Accounting

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In the world of accounting, there are two methods of recording income and expenses.  The best method for your business will be determined by your business’s size, structure, and tax filing intentions.  Smaller companies are typically on a cash basis because it tracks actual dollars coming in and going out.  Accrual basis tracks money when it is owed after a service is provided.  This applies to both money owed to the business and money owed by the business.  For instance, if you purchase a piece of equipment and aren’t required to pay for it for 30 days you would account for the transaction differently depending on the method you use.  In cash basis accounting, you would record the transaction when you actually pay for the piece of equipment after the 30 days.  In accrual basis accounting, you would count the cost when you acquire the piece of equipment.  The impact this has on your business is mainly seen at tax time.  If that same purchase was made in December, 2013 and paid for in January, 2014 any deductions would be claimed in 2013 in the accrual system, even though money wasn’t exchanged until 2014.

If your business does less than $5 million in sales per year, you most likely have the ability to choose either method.  However, neither is going to give you the entire story of your business’s current financial standing.  The accrual basis will tell you when you are doing the most work, but not necessarily when money is going in and out of your bank account.  The cash basis will give you an accurate depiction of how much actual money you have, but since you won’t account for it until you pay or get paid, it may not tell when your busy periods truly are, thus making it difficult to project future profits and plan for growth or downsizing.  To make the numbers work for your business, knowing what they actually represent is crucial.

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