The two principal methods of keeping track of the cash that flows in and out of a business are cash and accrual accounting. Most small businesses use the cash method, within which income is reported within the year it’s received, and expenses are deducted within the year they’re paid.
Under the accrual method, income is reported when it’s earned and expenses deducted when incurred, irrespective of whether money has changed hands yet.
Accrual Accounting
In a company using the accrual method, an accountant records income and expenses after they happen, not after they are literally received or paid. In practical terms, this difference in timing has relevancy if your company keeps inventory readily available or handles transactions on credit. as an example, a consultant completes a project in January but isn’t got it at the time. The business that has been serviced recognizes all expenses in reference to that contract after they were incurred, even though the consultant has not been paid. Both the income and expenses are recorded for this tax year, whether or not payment is received and bills are paid the subsequent February.
Cash Accounting
If an accountant uses the cash method, he/she counts income when it is received and expenses after they are paid. Many small businesses, especially retail businesses, use the accounting method of accounting, which is predicated on real-time income. On the day a check is received, it becomes a cash receipt.
