When a Small Business is created, it must embark on several activities such as registering the business, selecting a name, selecting the right business structure, among others. A vital piece of this puzzle is Small Business Accounting. This is to place on record every financial transaction of the Small Business. At any given point of time, if the owner wants to know the health of the Small Business – whether it is running profitably or incurring loss – the one and only way is to check the Profit & Loss numbers recorded by the Accountant.
There are two methods of Accounting for Small Businesses – Cash-Basis Accounting and Accrual-Basis Accounting. Small Businesses are free to select either of the methods, in accordance with the law and conditions imposed by the IRS.
Cash-Basis Accounting: This is the age-old and simple system, followed universally by businessmen owning Small Businesses. In this method, one’s income is taxable when it is received and expenses are deductible when they are paid. So this accounting system registers when money arrives, and registers expenses when money goes out. For Small Business Tax purposes this is a straight forward and easily understood method of bookkeeping.
Accrual-Basis Accounting: This method is an elaborate one, treating accounting events in real time, without regard to payments actually being made. In this system, income is recorded as soon as the sale takes place even if the payment for the transaction does not arrive until weeks or months later. Similarly when the business incurs an expense, the deduction is recorded immediately even if the payment is made at a later date. This bookkeeping system enables a small business owner to include such things as accounts receivable, accounts payable, and inventory when preparing financial statements. Due to the complexity if this system, it is advisable to have a Certified Public Accountant handle your books if you use the Accrual Basis.
For the purpose of Small Business Tax planning and paying Small Business Taxes, both systems are acceptable. The object of Small Business Tax planning is to maximize the profit and minimize the taxable income. So, the tax implications of each system should be analyzed when choosing which method to use.
For small businesses with gross receipts under $1 million (often referred to as MicroBusinesses), the cash-basis accounting system is typically recommended for its simplicity. For other sized businesses, the determination should be made based on tax planning purposes. If accounts payable is typically greater than accounts receivable, use the accrual basis. If accounts receivable is typically greater than accounts payable, use the cash basis.
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