Why Your Business Should Use Accrual Accounting

When you venture into business one of the decisions that you make is the accounting method that you will use. You may wonder what that means and why it matters. In the end, it is a decision to make. So let’s talk about the two accounting methods that you can choose from: cash basis and accrual basis.

Most businesses use cash-based accounting when starting because the owner already understands it. This method is commonly used by sole proprietors and small businesses. They record money when it is received and spent. Pretty simple and straight forward. This makes cash flow tracking easy. But is it the most effective way to keep business financial records? Cash basis accounting is not accepted by Generally Accepted Accounting Principles (GAAP) or banks. In addition, you should not use cash basis if you are selling inventory or have assets. So what should you do?

Accrual-based accounting is accepted by GAAP, banks and financial institutions. This method is more complex but your bookkeeper will handle it. With accrual accounting you have a more accurate financial picture of your business. Your bookkeeper can give you a statement of cash flows so you know how much cash is available. You can plan more accurately since the reports will include liabilities to pay in the future. If your business sells inventory products, you must use this method.

On that note, let’s discuss why your service-based business should sell inventory products. The most obvious reason is money. When you sell an inventory item you make money without working. Think of this as additional income for minimal effort. Inventory profit margin is also higher than for services. Most items have a markup of 100% or more. That equates to your cost equal to your profit. So if you invest $200 in inventory you will see an additional $200 in your profit.

The other reason you should sell to your clients is because they will purchase the items from somewhere so it may as well be from you. You use the products for the service you provide them. If they want the same results, advise them to purchase the products you used. Everyone knows you can find things cheaper on Amazon. Maybe the products you sell are available on Amazon too. If this is the case, explain to your client that buying from you allows them to help a local business and a person they are familiar with. Not a giant corporation. Just like the service you provide, make it personal. Let them know that you appreciate their business and that purchasing the item from you allows you to stay in business.

Now that you understand the difference between cash and accrual accounting you can make a more informed decision. Also consider adding retail sales to your service-based business to be more profitable. If you need a bookkeeper to track your finances contact me.