Picking the perfect accounting method for your business

Picking the perfect accounting method for your business

“Get the fundamentals down, and everything you do will rise” – Michael Jordan

When he made this quote, Michael Jordan was talking about basketball, but it can easily apply to business.  Business fundamentals are crucial, and nothing is more basic than selecting the proper accounting method.

If done poorly, you are almost guaranteed a series of financial headaches that will seem impossible to overcome.

But not to worry.

This post will help you pick the right system and give tips on where to go to ensure you made the right choice the first time.

Let’s go!

Cash Accounting vs. Accrual Accounting

There are two broad accounting methods. The most basic is cash accounting.

With it, you record income only when you receive cash and expenses only when you pay them.

Accrual accounting records income earned, even if you haven’t received payment yet. So, if you send an invoice for $100, it gets recorded as income, even if you’ve given the customer 15 days to pay it.

It’s the same with expenses. You record them when you incur them, not when you pay them. So, if someone sends you an invoice in March, you record the expense immediately, even if they’ve given you until May to pay it.

So, which method is better? Well, it depends on a few different factors.

Business Size and Complexity

If you run a service-based business with minimal inventory and few transactions, then cash accounting may be the best route, at least initially.

The more complex your business becomes, the more accrual accounting makes sense. It gives you a better financial picture when dealing with inventory, credit sales, and multiple departments.

There’s another reason to consider accrual accounting.

Regulatory Requirements and Minding the GAAP

IRS Code Section 448(a) generally requires C corporations and tax shelters to use an overall accrual accounting method (more on this later) unless that business has gross receipts of less than $29 million in 2023 and $30 million in 2024.

Of course, there are details to consider that go beyond the scope of this post. So, it’s best to check with a CPA if you have any doubts about meeting IRS requirements.

However, even if the IRS does not require accrual accounting, it is the only method that adheres to Generally Accepted Accounting Principles (GAAP).

GAAP is the standard accounting framework in the United States and serves as a litmus test for transparency and trustworthiness.

So, if you ever need to attract investors or secure loans, accrual-based financials will paint a more accurate picture of your business’s health.

One size fits all? Hardly.

Cash and accrual accounting are indeed the overarching methods. But each has nuances, and the IRS will let you mix and match to a certain extent.

If you want a deeper dive into this, check out IRS Publication 538. Or you can simply talk to a CPA about this option.

And while the IRS provides some flexibility in using the methods, it is pretty rigid about sticking to the first one you select.

You can change your method later, but you’ll have to get written permission from the IRS, and your books may be a bit chaotic for a while.

The Bottom Line

The accounting method you choose is going to have an impact on your business, so don’t wade into the decision lightly.

It’s one of those areas where talking to a CPA before you do anything is probably the safest bet. They can provide ideas and insights to help your business where it is now and provide for future planning.