Will that be cash or accrual accounting?

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It is important for a small business owner to pick a method of accounting. Generally, if you are reporting under $5,000,000 a year, the recommendation your financial accountant will give you is to report as a “Cash” basis. There are (or can be) tax advantages to the cash basis for smaller firms, but it can create some headaches in operations.

I remember my second year in business and how lost I was on knowing whether or not I was making money. We were set up on the cash basis in Quickbooks, following our accountants advice. The only problem is that we did a lot of commercial work. Many accounts were given 30 day terms, a few paid within 30, others were 45-90 days out. Under a cash basis, the program only counts income when it is received, and expenses when the check is cut, and the bills were paid. So no Accounts Payable, or Receivable get reported until the “Cash” changes hands. Not good. You can look like you are losing money, but have a bunch of receivables. Or, equally bad, if not worse- look like you are profitable to only figure out that the $50,000 material bill did not get paid yet. I am now starting to recall what happened to my hair.

What’s the answer? One option is to operate on the “Accrual” basis. This, at its simplest level, tracks income and expense at the time the invoice is created, and the time that the payable is entered into the system. Why is that “better”? It gives a better snapshot of true “Profit and Loss” ¬†on a specific point in time. The danger with the accrual basis is you can be profitable, but run out of cash, because you are waiting on receivables. Try explaining to your crew how payroll will be late, but no worries, the money is coming. Thankfully, I never went there- but there were Wednesdays that were spent running around collecting money so the crews got paid.

What’s the answer? I LOVED the toggle in Quickbooks between “Cash” and “Accrual”. Perfect? No. But it did get me close, quick. And it is really easy.

Here is the take away- No matter what reports you are looking at, know what their benefits and limitations are. This is really important stuff that can create huge stress if you don’t stay ahead of it. Before you know it you will be talking WIP accounts with the best of them.

Here is the link to the IRS publication which gives some of the more technical details.

http://www.irs.gov/pub/irs-pdf/p538.pdf

Be safe, it’s hot out there.

Hope this helps!

Gary Roux, MBA

 

Comments

  1. Rod Bailey says

    Cash basis and accelerated Dep’n for the Tax Man, Accrual and DDB for the manager.
    Especially for the smaller, under $5 mil business. Quickbooks makes it easy!

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