Accounting for revenues and expenses would seem to be relatively simple but most business owners know that accounting can lose all simplicity rather quickly. There are not many businesses today that can operate without being involved in credit card processing. The accrual method of accounting is best for most businesses selling on credit, regardless of their size or structure. For that reason, the accrual method also is the one used by most businesses.
Cash and Accrual Accounting Methods
The owner of a small business offering local services or operating a cash based business with no inventory may choose the cash method of accounting when the business is young. It is simple and straightforward, and it allows the business to recognize expenses as they are incurred but delay recording income received in the next accounting period.
A business with inventory must use the accrual method, however. Businesses structured as corporations that also have more than $5 million in annual sales also must use the accrual method. The accrual method almost always is best for any business that sells on credit, regardless of the company’s business structure or its level of annual sales.
Credit Sales Considerations
Under the accrual method, revenues and expenses are recognized at the time they are generated rather than when the expense is paid or the revenue is received. Cash or its equivalent does not have to change hands for the amounts to be recorded and recognized as either an expense or a point of income. This characteristic is one that makes the accrual method so attractive for businesses that sell on credit. Though each business may not receive money from credit card processing through merchant accounts until several days after posting credit sales, under the accrual method they count sales when they occur rather than when the businesses receive the resulting funds through their merchant accounts.
Recognizing income and expenses within the accrual method gives a clearer picture of business results for individual periods. As example, the business is able to count the sales made on the last day of September as revenue in the third quarter, though the time required for credit card processing may mean that the business does not actually receive revenue from those sales until early in the fourth quarter. Having a clearer picture of when expenses and income occur enables business owners to make better and more informed decisions about their businesses.