One of the key decisions you need to make when setting up your books is which accounting method you will use. There are two accounting methods to choose from: cash-basis accounting, and accrual accounting. The primary difference between the two accounting methods is the point when you record sales and purchase transactions in your books.
Cash-basis accounting involves recording sales and purchases when cash changes hands. Let's say a photographer is not paid right away for most of their jobs, but instead, they send an invoice to the customer that includes a payment due date. Until the photographer receives payment in cash, or by check or credit card, they do not count the photography services as income under the cash-basis accounting method.
Accrual accounting involves recording sales as soon as you have shipped the products to your customer, or have provided services. Going back to our photographer example, the photographer would count the services they provided as income once they completed taking pictures, regardless of when the customer actually pays for the services.
In general, most small business owners will start out using the cash-basis accounting method. However, according to the Internal Revenue Service (IRS), there are certain types of businesses that are not allowed to use this method of accounting.
The following businesses should never use cash-basis accounting:
- Businesses that carry an inventory
- C-corporations (regular corporations)
- Businesses with gross annual sales that exceed $5 million
One of the benefits of using QuickBooks is, regardless of which accounting method you choose, it does not change how you record transactions. As a matter of fact, you can start recording transactions in QuickBooks and decide later on which method you will use. This is because, at anytime, you can run reports for either method (cash or accrual). QuickBooks will determine which transactions belong on the report based on the accounting method chosen.