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How Business Accounting Works

Cash or Accrual

Somewhere along the line, you will be asked if your accounting system is on a cash or accrual basis. If all your sales are cash sales, and all your purchases are paid when you pick them up, then the answer is easy -- that is cash accounting. If, on the other hand, you deliver goods or services and are paid sometime later, or if you take delivery of supplies and pay for them at another time, an accrual basis might make more sense for you.

These two bases of accounting produce wildly different results. If you are already doing business and it is not strictly cash, you can try it both ways. Choose a month (or a quarter, if you don't have many transactions) and for that month, record cash in and cash out -- actual payments you receive and make. Add the columns (in and out) and subtract the smaller from the larger. You've just created a cash-basis Profit and Loss Statement (P&L) for the month (or quarter). Now, run the numbers again, but this time list invoice amounts and cash sales (but not payments on invoices), and list the invoices that you have received from your vendors and cash purchases you made. But don't list the payments you made on invoices. Add the columns and do the math. You'll get a different outcome. Accountants usually recommend the accrual basis to get a better picture of how your business is doing. This is one of the first questions you'll have to decide when you set up your books.