All businesses need to choose one of accounting methods.
It’s important to understand the basics of the two principal methods of keeping track of a business’s income and expenses.
The CASH method and ACCRUAL method (sometimes called cash basis and accrual basis).
In a nutshell, these methods differ only in the timing of when transactions, including sales and purchases, are credited or debited to your accounts. The accrual method is the more commonly used method of accounting.
Under the Accrual method, transactions are counted when the order is made, the item is delivered, or the services occur, regardless of when the money for them (receivables) is actually received or paid. In other words, income is counted when the sale occurs, and expenses are counted when you receive the goods or services. You don’t have to wait until you see the money, or actually pay money out of your checking account, to record a transaction.
Under the Cash method, income is not counted until cash (or a check) is actually received, and expenses are not counted until they are actually paid.
Example
Your computer installation business finishes a job in November, and doesn’t get paid until three months later in January. Under the cash method, you would record the payment in January. Under the accrual method, you would record the income in your books in November.
Example
You purchase a new laser printer on credit in May and pay $1,000 for it in July, two months later. Using the cash method accounting, you would record a $1,000 payment for the month of July, the month when the money is actually paid. Under the accrual method, you would record the $1,000 payment in May, when you take the laser printer and become obligated to pay for it.