Many small businesses, particularly sole proprietorships, handle their accounting on a cash basis rather than an accrual basis. Accrual accounting, which records expenses when incurred and income when earned rather than when cash actually changes hands, is more complicated to handle, but can give a truer picture of a company’s profit and loss per month. Cash accounting is based on when bills are paid and payments received. Besides the advantage of simplicity, it gives a clearer picture of cash flow.
1. Set up accounts that record the specific types of expenses you will incur. Business accounting programs generally provide a basic list of expense accounts as a starting point, such as advertising, office supplies, vendor services, office rent, taxes, insurance and professional fees. Add accounts that relate specifically to your business.
2. Create subaccounts to keep better track of expenses for specific items. Under office expenses, for example, you can create a subaccount for printer’s ink so that at the end of the year you have a figure you can budget for the following year or adjust if you buy a new printer that uses cheaper ink.
3. Record expenses as you pay them, including vendor payments, debit card payments, payroll, taxes and miscellaneous expenses. If you run a business accounting program to write your checks, the program will generally require you to enter the appropriate account the payment is attributed to before recording the payment, simplifying your bookkeeping. Run monthly reports on expenses and income to keep track of your business cash flow.
- While many small businesses use a dedicated business accounting program, you can use a basic spreadsheet program or even a pencil and ledger book. But the Internal Revenue Service now accepts electronic records from business accounting programs if you’re ever audited, reducing the need to come up with boxes of receipts to verify your expenses.
- In many cases, there is no tax requirement on whether you use a cash or accrual accounting system. The IRS, however, will generally require you to keep an inventory and use accrual accounting for sales and purchases of merchandise if you purchase, produce or sell merchandise as a primary part of your business.
- Be consistent. You do not need IRS approval to set up either a cash or accrual system for your first tax return, but you can’t change your accounting method in the following years without approval from the IRS by filing Form 3115.
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