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Accounting

What accounting method are you using? Was that method part of your business plan? Let’s look at the two common business accounting methods.

Cash Accounting

Cash accounting is fairly straightforward and is by far the easier accounting method of the two to manage. This method is what most small businesses use.

 

Cash businesses operate on a bill and payment only basis; a service or product is provided, and then an invoice is presented. Payment is not counted until the customer has actually paid for the invoice, at which point the money is transferred to the bank.

 

Usually, the cash method of accounting takes place on a month to month basis, showing a loss or a profit in terms of real money at the end of each period.

 

Accrual Accounting

With the accrual method cash is counted not when it is received, but when it is billed.   This method allows a business to look stronger monthly ahead of actual income. Most businesses using this method are using a heavy amount of revolving credit from a funding source (usually a bank) to support payroll and overhead operations. Most small businesses with fewer than 3 locations need not use this. However, consider this method in your expansion plan as it will allow you, in most cases, to carry more credit.

 

You still need to keep track of the cash when the invoices are paid, but you have already accounted for the cash in the month when you completed the contract (or when you sent out the invoice).

 

The Advantages of Both Systems

As I mentioned above, the cash system is much simpler to use than the accrual system, simply because it does not require as many steps before it is complete.

 

In addition, cash accounting will give you an idea of the real money that your business has to work with; you won’t need to operate on credit. However, real dollars can be an emotional experience in a down month so be prepared.

 

The accrual method, on the other hand, can give small business owners a much more accurate picture when it comes to the trends of their business. Trends are important in heavy volume transactions that a business conducts. It can determine the needed workforce, payroll loan amount, overhead expenses, and ODC’s (other direct cost’s).

 

You can tell from a simple glance at the books when your busy months were and when the slow months were because the positive dollar signs will indicate that it is so.  On the other hand, accrual accounting doesn’t rely on ensuring that all the money that your are owed has actually been collected; businesses using this method run the danger of running out of cash before all the bills are paid, but they are showing sales in the time they occurred.

 

The choice between the two methods of accounting is mostly up to you, with one exception.

If you run a small business which keeps a large inventory, you may be forced by the IRS to use the accrual method. In all other cases, it is a matter of whether you want a picture of your company’s performance or actual earnings.

1 Comment »

  1. How to Finance a Business

    If you are starting a business from scratch, then you will need money to buy equipment and supplies, establish office and pay for needed services. You will also need money to pay off the first installment of bills before you generate income. In such a case, financing is the best option to get your new business off the ground.

    Our M.B.A. EJ Owens says:

    Start the business with a specific plan of how it is going to operate, at what levels it needs financing and when the funds will be needed.

    Calculate your start up costs and expected bills. Discuss with your financer, the possibilities of financing up to the first 6 months or as required.

    Use either your own money to finance or ask friends and acquaintances to chip in. Remember the 3 F’s of Financing “Friends, Family, and Fools” all will give you something, so start there! Also contact the government to inquire about grants.

    Finance the most important thing in your business. Go through the available financing options offered by banks or outside investors. When financing through a bank, discuss all possible business angles and arrive at the best possible financing option. Remember, you negotiate the amount, they negotiate the interest!

    Opt for micro financing if you only require a small amount of financing. Contact your local Community Development Finance Institutions (CDFI), an organization that backs small projects. For an all women business, separate financing options are available too. Other financing groups include the Asian Business Development Network (ABDN) and Black Business Initiative (BBI).

    Select financing that offers easy terms, low interest rates and easy payment plans. Don’t always take the full amount they offer. Use a POA&M schedule for “chunks” of money. Use your Plan of Action and Milestone Schedule to determine how much you need of the money and how long you need it for.

    Example:

    You asked a bank to finance you $1,000,000.00 for 3 years. They like your business plan and you have presented a solid strategy for success. They offer you the total amount up front. Instead of taking the full amount, and immediately start paying interest on the full amount, take a “chunk” of it. How does $200,000.00 sound? Use it and start paying on it before you take the next amount.

    Getting in over your head financially is how most small business becomes a statistic. Consult successful business professionals for advice; notice I said “successful”.

    -Your M.B.A. EJ Owens

    Comment by kellsibley | August 25, 2008


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