One of the decisions every business owner must make is whether to keep the books on the cash basis or accrual basis.

Accountants will almost always tell you the accrual method is preferable. While it seems that accountants sometimes makes things more difficult just because they can, in this case there is actually a good reason for the recommendation of accrual basis accounting over cash basis.

Which one you choose will depend on your objective.

If your objective is just to keep your checkbook balanced, then the cash basis method will be adequate. If you only provide one or two services or a handful of products, your needs are going to be different from a business with a more complex business structure. Or perhaps you are just starting out; you are building your infrastructure and don’t have many sales yet, just expenses. In that case, cash basis accounting is likely exactly what you need.

It can be relatively simple to convert from cash basis to accrual basis accounting. You may have to pay an accountant to do it, but once your business is up and running, you should be able to afford it. Besides, you don’t want to learn accrual accounting yourself, do you?

Another method of handling this would be to operate under a cash basis sole proprietorship, partnership, pass-through LLC, or pass-through S-Corp. By “pass-through”, I mean structuring the business so that the net income or loss flows through to your individual tax return, just as it does with a sole proprietorship. Use this entity for the research and startup phase, and then once you are ready for business, start an accrual basis LLC or corporation.

It is an option worth considering with your attorney and tax professional, especially if the thought of doing one of these cash-to-accrual conversions makes you dizzy.

As I mentioned earlier, cash basis will allow you to keep your checkbook up to date, and for many business owners, that is enough. You may be wondering, why would anyone want to deviate from such a simple approach?

Here is the truth of the matter: accrual basis accounting is one of the great contributions of the accounting profession. For many kinds of operations, the accrual basis of accounting is the only way to determine whether you are profitable or not.

The basic difference between the two approaches is this:

• Cash basis accounting: record revenues and expenses as they occur
• Accrual basis accounting: record revenues in the period in which the occur, and record expenses in the period in which they occur in the process of generating revenues. Accrual basis accounting is more concerned with the substance of transactions rather than the timing of when you write the checks.

In summary:

• As a business owner, you must choose between cash basis and accrual basis accounting
• Your choice can be changed at a later date
• Cash basis is easier, but accrual basis can be more accurate in determining profitability

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