Are You Keeping Good Track of Your Business?
The Executive’s Guide to Carpet Cleaning Part I: FINANCES
Advanced Concepts: Cash Vs. Accrual
You can track your business’s income and expenses in several ways. The two most common methods are Cash and Accrual (also called Cash Basis and Accrual Basis).
In most cases, you can chose which method you would like to use. Understanding the advantages and disadvantages of each will help you to identify which one is right for your business.
Cash: Most small businesses use the Cash method. It operates on the assumption that income is only income when you receive a payment and expenses are only expenses when you submit a payment.
If you have no Accounts Receivable, then using the Cash method will make little difference to your income. Your expenses, however, will be a different matter altogether.
Accrual: The Accrual method essentially moves the transaction date forward. You count income on the date you do the work, and you count expenses on the date you receive a bill.
Additionally, if you purchase items that will be used in the sale of a product or service, it’s possible to keep the inventory as an asset, and only claim the expense when you close the sale. With the Accrual method, the actual cash flow is of little relevance
Which one to use: Generally speaking, you don’t have to use the Accrual method unless your gross sales are over $1 million for a given year. Both methods have their good points and bad points.
Neither will give you a truly complete picture of your business’s position.
Accrual will do a better job of leveling the ups and downs of your business’s income. On the other hand, determining your cash flow can get really tricky, especially if you have capital assets like trucks, vans, and equipment.
If you don’t account for real tax dollars, the result could be a serious cash flow problem.
Let’s look at an example. Let’s say you purchase a new van and truck-mount for $20,000. You may only be able to expense, or write off, $5,000 of that expenditure on this year’s taxes.
What happens to the other $15,000? That amount is recorded as an expense over the next few years. Your tax liability will include a $15,000 “profit” for which you have no money.
It’s these kinds of issues that can catch you off guard if you’re not watching them closely. Current tax laws allow for the immediate expense of some capital purchases. Your accountant can address the issue of depreciation for your business, but you need to be able to ask the right questions to help direct them.
Cash will provide you with a more reliable picture of your company’s cash situation. However, this method can misrepresent your long-term profitability.
You may look good for a given month, even though sales are slow, because you happen to receive a number of back payments. When you are looking at the big picture and attempting to answer difficult accounting questions, looking at a group of monthly cash-based numbers will not do you any favors.
Ultimately, you should make the decision between Cash and Accrual with the help of your accountant. Switching methods is a real pain, and you only want to do it when it will be in the best interest of your company.
Having a solid understanding of both of these methods will help you to get a real snapshot of how your business is doing right now–and how it will be doing in the future.
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