Accounting is an important operation that every small business must perform. It is the formal practice of ensuring that all revenue is received, debts are paid and books are balanced. Completed on a daily, weekly or monthly basis, accounting allows a small business’s management team to accurately assess the organization’s financial position. Cash and accrual are the two standard accepted accounting methods.
The accrual method of accounting is the practice of recording income the instant a sale is made, whether payment has been received or not. For example, if a retailer sells an item and accepts cash on the spot, the cost of that item is immediately recorded as revenue. Likewise, if a retailer bills a customer for payment at a later date, the income is still immediately recorded. On the flip side, the accrual method also recognizes debits the moment small businesses are liable for them. For example, if a business uses credit to order a service from a vendor, the cost of that service is immediately deducted from the general ledger. The Internal Revenue Service requires most small businesses maintaining inventory to use the accrual method.
Unlike the accrual method, the cash accounting method requires transactions to be recorded only when money is received or paid. Although the cash accounting method is commonly used when tracking personal finances, it is typically not recommended in business settings. This is because cash accounting can terribly distort the finances of a small business. For example, if an organization has been paid by all customers for services rendered but has not paid its own debts, the general ledger will incorrectly report that the firm has more money than it actually does. Likewise, if the organization has paid each of its debts but has yet to receive payment from customers, the general ledger will indicate that the company is in the red.
Manual vs. Electronic
In addition to choosing between accrual and cash accounting methods, a small business must decide whether to maintain its accounting records manually or with the use of computerized software. Computerized accounting systems provide an expedient and efficient method of tracking all financial transactions. In addition, these programs automate many of the accounting processes, such as calculations. This minimizes the occurrence of human error. Unlike manual accounting, however, computerized systems are susceptible to malfunction during power outages. They are also vulnerable to security breaches.
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