Does It Really Matter What Accounting Method I Use?

by Debi Enders

In a word, yes. The method you select can potentially impact everything from your tax liability to your ability to secure a loan. So it’s important to know the differences between the two - cash or accrual accounting.

Under the cash method, business income is recorded when you receive it and expenses are counted when you actually pay them. With the accrual method, by contrast, transactions are recorded when they are completed regardless of when cash actually changes hands.

There are advantages and disadvantages to both approaches. The cash method, for example, gives you a clear picture of the funds in your bank account but may offer a misleading picture of your business’s longer-term health by not providing visibility of your unpaid sales and expenses. The accrual method can also paint an incomplete picture. With it, your income ledger may show thousands of dollars in sales while your bank account is empty because your customers haven’t paid you yet.

While cash accounting is simpler and therefore more popular among small businesses, the accrual method is required for businesses that 1) have sales of more than $5 million a year or 2) maintain an inventory of products sold to the public and generate more than $1 million in gross receipts annually.

Because the method you choose will impact which year income and expenses will be counted and when you can claim deductions, it’s wise to consult with your accountant to determine the best approach for your business.

You may want to talk with your banker as well — especially if you plan to seek financing.

Since lenders review tax returns as part of loan applications, you will likely want an approach that best demonstrates your ability to repay a loan, so choose wisely.

Debi Enders (debi.enders@commercebank.com) is vice president, small business banking at Commerce Bank.