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April 16, 2024
A comprehensive guide to choosing the proper accounting method for your business.
Managing finances is crucial for any small business. While incoming revenue and profit might be significant, cash flow indicates your company’s financial health. Hence, keeping a close eye on outgoing and incoming transactions is essential for understanding your company’s economic status.
Now, how can you keep a keen eye on such transactions? Accounting is the only primary function for all small, mid-sized, and large businesses. Mastering accounting is critical to achieving business success, as it provides the essential tools to monitor and optimize financial performance.
Accounting is the holy grail of running a successful business. If you’re a small business, a command over this fundamental business function can propel your company from strength to strength. Practical accounting lets you track every dollar spent and earned, providing vital insights into your business’s financial activities. It is invaluable for making informed decisions and ensuring your business’s sustainable growth and profitability. Let us tell you how.
To grasp the significance of accounting and its various types, we must delve into its essence and understand its impact on businesses of all sizes.
Accounting is the process of monitoring and recording all financial inflows and outflows within a business. While this definition is straightforward, accounting involves more intricate tasks. Business owners must document transactions and categorize and classify them accurately to ensure compliance with legal regulations and precise tax reporting.
To better understand accounting, consider it’s like maintaining a detailed diary or budget logbook of financial activities. Just as individuals track personal expenses to manage budgets effectively, businesses use accounting to record and organize their financial operations meticulously. This systematic approach helps generate financial reports that provide further insight into a business’s economic performance. Ultimately, accounting is the foundation for sound financial management and decision-making.
While there are many accounting methods, cash and accrual accounting are the two most important.
Fun Fact: The IRS requires every company, whether a small business or a big multinational company, to pick one particular method of accounting for each tax year. Switching between different methods can allow companies to find loopholes and manipulate financial statements to evade paying accurate taxes.
Let’s take a closer look at the types of accounting methods:
Small businesses, listen up; this one’s for you. Cash accounting is a method most commonly used by new and small companies trying to establish themselves. In this method, transactions are only recorded when cash is spent or received.
This means that whenever a sale is made, the cash received will be recorded, and whenever a bill is paid, the cash spent will be recorded, making it pretty simple for new business owners to navigate the process. However, this method works well for individuals or businesses with a relatively smaller size to keep track of and adopt into their day-to-day operations.
Big businesses have innumerable daily transactions, and keeping track of all those transactions at once is difficult. The accrual method comes into play, wherein the matching principle is used. In this method, the time of revenue is matched with the time of expense to paint a precise picture of incoming and outgoing cash flow.
In this method of accounting, all transactions are noted as soon as they occur rather than when the payment is made. That sounds pretty confusing. Let us explain.
This is similar to how a credit card functions: a business’s purchase is often recorded even though the payment might not have been made then.
| Talk to us about how Escalon’s FinOps can help you gain financial insights to make informed decisions. |
Picking the proper accounting method for your business will truly help your business grow. It can be highly beneficial to you in the long run. One of the biggest things to remember when picking a method that fits your business model is that the technique should align with your business goals. If you aim to keep your business small and manageable, cash accounting might be the best for you, but if the sky’s the limit, then accrual accounting will be the right fit. While this helps give a broader overview of what the two can do for your business, diving deep and considering two critical factors that may affect your choice is essential.
One crucial aspect of any business is revenue and how it’s reported. Your choice of revenue reporting method is influenced by how you charge clients and deliver services. For example, tracking every daily transaction is nearly impossible for a large multinational company. Still, it might be manageable and the preferred option for a small business.
For example, consider a SaaS startup using a subscription model versus a small-scale business using a straightforward purchase and payment model. The SaaS startup’s accounting and reporting would be more complex, likely requiring accrual-based accounting. At the same time, the small business might suffice with a simple cash accounting method. Business owners should assess their current needs and complexity to make an informed decision.
As a small business owner, one must consider how slowly or rapidly you want to scale your business. Anticipating scaling for the next few years can help you pick an accounting method better aligned with your future needs. If growth is evident shortly, choosing the accrual accounting method might benefit your business. However, going down the cash accounting method is the most efficient if it’s still far ahead.
Maintaining accurate and up-to-date financial records in business is not just a formality—it’s a strategic imperative. These records serve as your business’s pulse, offering crucial insights into its financial health and performance.
By diligently tracking income and expenses, business owners can monitor their financial situation and make informed decisions regarding growth strategies accordingly. By maintaining dated records of economic performance, a business owner can identify warning signs of financial trouble and conduct meaningful comparisons with historical data to steer the company in the right direction. Lastly, accounting methods empower business owners to manage their finances and drive long-term growth proactively.
No business owner, big or small, wants to pay more taxes than necessary. Accounting helps you track expenses and earnings accurately, ensuring you pay the right amount of tax on your income. For those new to business, navigating complex rules and changing regulations can be daunting. In such cases, outsourcing your accounting needs to experienced professionals can help prevent costly mistakes.
As a small business owner, it’s essential to consider how you want to scale your business. Thinking about your scaling plans for the next few years can guide you in choosing an accounting method that aligns well with your future needs. If you anticipate significant growth shortly, opting for the accrual accounting method could be advantageous for your business as your business may experience a lot more costs and payments, causing a massive influx and outflux of capital. However, if substantial growth is further down the road, using the cash accounting method might be more efficient for now, for smaller transactions are easily manageable with this method in use.
In conclusion, selecting the proper accounting method is imperative for businesses, as it serves a fundamental function that can drive growth and success. Key stakeholders must be familiar with different accounting methods to align them with business goals effectively.
These methods ensure a business stays afloat and propel it towards success.
The proper accounting method catalyzes business growth by fostering transparency, enabling financial analysis, and supporting long-term sustainability. It empowers business owners to leverage financial data as a strategic asset, paving the way for informed decisions and agile adaptation in a dynamic marketplace. Therefore, investing time and resources into selecting and implementing the appropriate accounting method is not just a prudent choice—it’s a critical step toward unlocking your business’s full potential.
If you need help structuring your accounting or deciding what steps to take next, outsourcing your accounting needs to a third-party company can provide valuable perspective and resources necessary for flourishing in your industry. With the right accounting approach, businesses can optimize financial management and pave the way for reduced costs, sustained growth, and achievement.
Want to know more? In addition to HR, benefits, recruiting, and payroll through its PeopleOps, Escalon’s Essential Business Services include FinOps (CFO services, taxes, bookkeeping, and accounting) and Risk (business insurance). Talk to an expert today.
This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal, or accounting advice in this article. If you would like to engage with Escalon, please get in touch with us here.
With 6 years of experience in copywriting and social media management across genres, Devayani's heart lies with weaving words into stories and visuals into carefully crafted narratives that’ll keep you wanting more. She carries with her, her pocket notebook, a trusted confidante that goes with her wherever she goes, and scribbles down into it anecdotes on the go. Her secret weapon for keeping all things copy interesting! Apart from writing, Devayani is huge on travelling. You'll find her booking her next adventure while she's on her current one. And while on those adventures, you'll find her devouring true crime books one after the other. Whether it's a low down on a recent case or one that occurred 70 years ago, she can cook up a story narration you'll never forget.
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