From a tax standpoint, it is sometimes advantageous for a new business to use the cash method of accounting. That way, recording income can be put off until the next tax year, while expenses are counted right away.

With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. An excellent example is a sale on credit. The sale is entered into the books when the invoice is generated rather than when the cash is collected. Likewise, an expense occurs when materials are ordered or when a workday has been logged in by an employee, not when the check is actually written. The downside of this method is that you pay income taxes on revenue before you’ve actually received it.

Should you use the cash or accrual method? The accrual method is required if your annual sales exceed $5 million and your venture is structured as a corporation. In addition, businesses with inventory must also use this method. It also is highly recommended for any business that sells on credit, as it more accurately matches income and expenses during a given time period. The cash method may be appropriate for a small, cash-based business or a small service company. You should consult your accountant when deciding on an accounting method.

Excerpted from Start Your Own Business: The Only Start-Up Book You’ll Ever Need, by Rieva Lesonsky and the Staff of Entrepreneur Magazine,  1998 Entrepreneur Press

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