Choose an Accounting Method
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The two basic ways to account for your income and expenses are the cash method and the accrual method, and some businesses use a hybrid.
The Cash Method.
Using the cash method, you record income when you actually receive it and expenses when you actually pay them. For example, if you complete a project in December 2008 but don't get paid until March 2009, you record the income in March 2009. Similarly, if you buy a digital camera for your business on credit, you record the expense not when you charge the camera and take it home, but when you pay the bill.
The Accrual Method.
Under the accrual method, you record income as you earn it, and expenses as you incur them. For example, if you complete a project in December 2008, that's when you record the income you expect to receive from it, no matter when the client actually gets around to paying you. (If the client never puts the check in the mail, you can eventually deduct the money as a bad debt.) And if you charge some furniture, you record the expense on the day of purchase, not when you pay the bill.
Which Method is Best?
So which method is better? It depends, of course. The cash method is much easier to use; most of us deal with our personal finances this way, so it's a system we're familiar with. It also gives you a clear picture of your actual cash on hand at any point in time. The accrual method can't tell you how much cash you've got, but it provides a more accurate picture of your business's overall financial health, particularly if your clients or customers are pretty good about paying their bills. It will show money that you've obligated yourself to pay, so you'll know that you can't count on using that money for other purposes. It will also show money you can look forward to receiving (again, if your customers pay you as promised).
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