Are you considering using accrual-based accounting for your
small business? Some businesses must use this method, but many others have the
choice. The decision between using cash and accrual accounting affects how and
when your revenue is recorded.
To help you make the best decision about accounting methods,
here's what you need to know about accrual accounting and how it might be
important for your business.
There are two main methods for recording your company's
revenue and its expenses. The first is the cash method of accounting. This
simply records revenue when you receive the money and expenses when you pay the
money. It's simple and often the go-to option for small-business
entrepreneurs.
The other choice is called the accrual method. With this
system, the company matches the reporting of revenue and expenses with when the
business gets the benefit of these. For instance, once you send out an invoice
for finished goods, you may report that income even before the customer's check
arrives. This is because you have an unencumbered right to the revenue
earned.
Some businesses are required to use the accrual method, at
least for a portion of their operations. Generally, this includes any company
that maintains inventory. This is in order to match up the purchase and
maintenance of inventory with the production of and payment for finished
goods.
In addition, you may have to use accrual accounting if your
business is a C corporation or your revenue is greater than $5 million
annually. When corporations and larger businesses use the same accounting
methods, you can more easily and accurately compare companies' profits, losses,
and accounting standards.
If you're not subject to this requirement, should you choose
accrual accounting anyway? First, accrual accounting is a good idea if you have
significant revenue or expenses that you prepay. For example, if you prepay for
annual insurance, cash accounting would show a large expense in January but no
insurance costs for the rest of the year. Accrual accounting more accurately
reflects your ongoing insurance costs.
Many businesses buy and sell items or services on credit.
They may receive the items 30, 60, or even 90 days before an invoice is due.
With cash accounting, you may report the cost you incurred to make something
several months before or after you recognize the sale. Your books would be
inaccurate, and your decision-making information would be out-of-date unless
you accrue these items to match them within periods.
Accrual bookkeeping can also help a business that often does
work on long-term contracts or large projects. For example, a construction
company that does projects over the course of 3, 6, or even 12 months may buy
materials months before they use them or before they earn the accompanying
revenue. By employing accrual methods, you keep expenses and earned income in
line so you know how the project really is.
Finally, a business that grows and thrives may have to
switch to accrual accounting once it reaches certain thresholds. If you plan to
hit that $5 million revenue threshold soon, for instance, a switch to accrual
methods now is a proactive move that makes future growth less disruptive.
Do you want to know more about whether you must - or should
- use accrual bookkeeping? Start by meeting with the accounting team at Quality Bookkeeping Services
Inc.
today. We will guide you through this decision and help you implement
the best choice for your company. Call to make an appointment. We look
forward to helping you with your accounting.
