When setting up a bookkeeping system for your company, it is important to understand the definition of the cash method and the accrual method of accounting. Under the cash method, revenue and expenses are recorded according to the flow of cash in and out of the business. Under the accrual method, revenue and expenses are recorded when incurred, usually in the absence of a cash transaction. The cash basis is an easier concept to work with but does not always give you a true picture of business operations. The accrual basis will give you a more accurate picture of your company’s results of operations, but requires a bit more work.

Characteristics of the Cash Basis:

a. Deduct your business expenses when paid. ( Ex: Record expenses on the books only when cash goes out the door)

b. Record Income when you receive payments from your customers. (Ex: Recognize income on the books only when cash comes in the door)

c. At year end, only expenses paid during the year and income received during the current year will be recorded on the tax return. (Ex: If customers were invoiced a total of $75,000 late in December and payments on those invoices have not been received by December 31^st, that income does not show up on the tax return. Likewise, if invoices from your supplier totaling $75,000 are being held but not paid by December 31^st, those expenses are not deducted on the tax return)

Characteristics of the Accrual Basis:

a. Business expenses are deducted when you receive goods or services usually before they are paid. (Ex: Record expenses on the books when goods/invoices are received from your suppliers, before you send your payment.)

b. Revenue is recognized when you provide goods or services to your customers, even if payment has not been received. (Ex: Record income on the books when services are rendered to customers or goods are sold, prior to receiving payment)

c. At year end, unpaid invoices/receivables to customers could be sitting on the books which create taxable revenue for the current year, even though payment has not been received from the customer.

d. Likewise, at year end, unpaid bills to vendors/payables could be recorded on the books for expenses that have not yet been paid. These expenses will reduce taxable income.

Situations where the Accrual Method is required:There are some situations where the accrual method of accounting is required. However, for most small businesses, these situations probably do not apply. If you have a corporation that has annual gross revenue of $5million or more, you must use the accrual method. Additional if you carry inventory on the books or if your business is engaged in farming operations, you might be required to use the accrual basis.

Change in Method of Accounting:

Once a method of accounting is adopted, this method needs to be followed year after year for tax purposes. However, if there are specific reasons to change methods that might prove to be more advantageous to your business, you might consider changing methods. To change to a different method of accounting used in reporting taxable income on your business tax return, the corporation must file a Form 3115 – Application for Change of Accounting Method to receive approval from the IRS.

Small business accounting software will usually allow the presentation of the financial statements on either a cash or accrual basis. However, for tax purposes, arbitrarily switching back and forth between the two methods is not allowed.

In Conclusion, for most small business with revenue under $5 million, it is probably best to use the Cash method, especially if those businesses carry large receivable balances on the books. By carrying receivables, this means that you have invoiced customers, but not actually received payment from these customers. At tax time, those invoices are disregarded and will Not result in taxable income. Because, under the Cash method, only cash actually received during your tax year has to be reported as income on the tax return. For businesses that do not carry large receivable balances, it might be more beneficial to use the Accrual basis of accounting. This would allow deductions for business expenses that have been incurred but not yet paid. Some businesses plan on accelerated spending at year end for this purpose.

Intuit, the makers of QuickBooks and other popular business technology solutions have put together a small business report that is authored by The Institute for the Future. This is a three part study that examines trends for small business over the next 10 years. Part one of the study was released in January 2007 and it focuses on “Demographic Trends and Small Business”. Part two of this study was just recently released and it focuses on “Technology Trends and Small Business”.

The link to both parts of the Study and to the Intuit site: http://www.intuit.com/futureofsmallbusiness

According to Hoovers, the top technology trends for small business in 2007 are:

• SEO or Search Engine Optimizaton: To ensure a strong web presence that gives your web site maximum exposure on the net, a significant amount of time and resources are needed to develop SEO strategies.
• Marketing Partnerships: In order to cut the costs of generating new business, many small businesses are turning to marketing partnerships to generate new leads.
• Computer Security: All businesses must put in place certain safeguards to ensure that their confidential information is protected at all times. At the very least a small business should protect their proprietary databases from competitors, former employees, would be hackers and all types of malware. There should also be regular daily or twice daily backing up of data. Web based backup services are fairly new and should be looked into. Then of course having a formal, written contingency plan such as a plan in the event of a natural disaster should be the ultimate goal of all small businesses.