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Accounting Methods
Cash vs Accrual
Many businesses maintain their books on a “cash basis” because they do not understand the accrual method or they consciously want to defer paying income tax. However, when it comes to managing their business, every business should look at BOTH cash and accrual based income statements because each are important to understanding the actual performance of the business.
Cash basis income statements are the simplest because with few exceptions it represents actual cash inflows and outflows during the period. That is, it represents the deposits to the bank, and the checks written during the period. Cash is “King” in every business and the owner has to deal with the cash requirements of the business on a daily basis but it does not tell the owner if the operations are profitable.
Accrual basis income statements are more accurate and offer the actual profit picture of the business. Unfortunately, it does require that accounting categories be defined and procedures followed. For instance, only revenue earned should be used as actual revenue while deposits received would not be revenue but shown as a future liability. Invoices issued before work was initiated would be unearned revenue and would be shown as a backlog. This requires that inventories and work in process be estimated or physically calculated for that period so that an accurate profitability picture can be seen. Inventory built for stock or project revenue invoiced but not earned can be seen with accrual accounting but is totally lost with a cash system. Actual expenses can be prepaid and shown as an asset if not incurred during the accounting period. The business owner will want to understand if the income generated exceeded the expenses incurred and the company’s profitability justifies the investments being made.
QuickBooks is an amazing tool for small businesses because for the first time an affordable accounting package exists that allows businesses to be run professionally and managed by owners with little accounting background. A large number of consultants exist who support QuickBooks so it is possible to have a consultant come in for one or two hours a month to act as an auditor to review account entries and look for mistakes. This assures the owner that the books reflect the operation of the business and eliminates costly cash or profitability surprises. QuickBooks statements can be seen on either a cash basis or an accrual basis by merely setting a software switch. By using both statements (cash and accrual) you will be getting critical information about your business from two different but equally important perspectives.
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