Accounting services use two main methods to take care of a company’s financial records and to prepare reports.
There are rules and guidelines to follow and two main record-keeping methods one can follow:
cash basis and accrual basis.
A business must therefore decide which of the two types fits best with their industry and size. Small businesses in particular will decide according to their legal form, volume of sales and tax requirements.
As the IRS requires by law that all companies keep a record on all financial entries and expenses, this information can also be very useful to access the financial situation of the business, which can then decide what decisions should be made to improve the management of sales and services.
If you do choose one type of accounting method to start off with you can always change later, although this process can be complicated, so it would be best to choose the right one for your business from the start.
So try and work on finding the most suitable method for your particular business as soon as you create your own company, in order to avoid tiresome formalities later on.
With the cash basis system all accounting records recognize expenses and income on the basis of real time cash flow. Once the funds are received then the income is reported and not based on when it is earned. Expenses are recorded the moment they are paid out and not when they actually occur.
This means that with this type of accounting method you can defer all income that can be taxed and delay billing in order that payment is not received in the current year. You can also speed up expenses by paying them as you receive the bills before the date of expiration.
With this cash method you have quite a few advantages, for it is easier to understand than the accrual method and will give you a clearer picture of your cash flow, in addition to the advantage that your income is only subject to taxation when it is actually received.
On the other hand the accrual basis will recognize more accurately your income and expenses during the period in which they apply, independently from whether the money has changed hands or not.
With this system, you will be recording money when it is earned and not when the payment is received. The same can be said for the expenses that will be recorded when they are incurred and not when they are made.
The accrual method has the advantage of providing you with a clear view of how your business is proceeding on the long term as opposed to the cash flow method, while it can be more difficult to understand and manage.
Usually, the accrual basis of accounting is required if your business handles any inventory, from smaller retailers to bigger manufacturing firms.
There is also a minimum fixed sum for gross sales per year for companies to qualify for this system and must be used for all financial reporting and credit purposes.