Cash Versus Accrual; How Do I Account for My Small Business?

For a traditional small business, there is no right or wrong method for accounting. However, cash versus accrual always seems to be a hot topic that small business owners and entrepreneurs want the answer to. I am glad that this question is constantly being explored because accounting for small businesses is extremely important, along with choosing the correct accounting method for your own small business. Each method has its own advantages and disadvantages and this article from NOLO online does a great job of exploring both.

The cash method (or cash basis) is the more preferred of the two accounting methods. Income, sales, and revenues are not recorded until the cash is actually received. Expenses are also not recorded until the cash is paid out. This is a very simple method and it sticks by its name. This method gives you a more accurate depiction of how much cash you really have. On the down side, it can portray a distorted picture of long-term profitability. You can have a month where sales are slow but receive customer credits from the last three months. In this instance, although sales are low this month, the records show sales from the past three months all being recorded in the same month. A business must keep monthly totals of accounts to understand the books completely. As long as you understand the delay in recording income and expenses, small businesses can have great success using this method.

The accrual method (or accrual basis) records a transaction when the expense or sale is incurred rather than when the cash is paid-out or received. For service-based companies, you record the sale when the service is 100% completed. This goes for expenses, as well. This method is great for showing business income, expenses, and debts as they are incurred. The downside is that it may not give you an accurate picture of what your cash flow looks like. For instance, you can have thousands of dollars in sales but your bank account does not reflect this because your customers haven’t paid yet. It is important when using this method to constantly remind your customers of what they still owe and to keep a close eye on your bank accounts.

When choosing the correct method for your business, there are a couple of things to keep in mind. The first is that if your business has sales over $5 million in sales you must use the accrual method. Next if your company sells products to the public and you have an inventory, you must use the accrual method when gross receipts exceed $1 million. As long as your businesses sales are under those two thresholds you are able to choose either of the methods. You can even switch from one method to the other, as long as you consult with your tax expert first. As far as tax deductions go, under the cash method you cannot claim deductions if they are incurred in 2012 but paid in 2013. Under the accrual method you can record those expenses when incurred and claim them in 2012.

I hope this helped answer some of your questions regarding cash vs. accrual methods of accounting. For more information check out the article on NOLO online or consult with your accounting/tax expert.

Structuring Your Business Venture

You’re almost ready for your grand opening! You completed your business plan, found a place to rent, filed your fictitious name, and tied up almost all the loose ends. The big question, which you’ve been putting off, is how do I structure my business? What is my personal liability? What are the tax implications and forms that need to be filed? Am I going to be able to raise money with this structure? Many potential business owners struggle with choosing the correct way to structure their business. This decision does not have to be stressful if you are aware of the different business structures. According to an article posted on Entrepreneur Online, the three most common forms of business structures include: sole proprietorships, partnerships, and corporations.

Forming your business as a sole proprietorship is the most common and simplest way to structure your business. Businesses usually choose to structure this way when there is a single owner and operator and a limited number of employees. Taxes are filed on the Form 1040 and profit or loss is recorded on the Schedule C.  The bottom line of your business operations is then transferred to your personal tax return. Schedule SE should always be filed. One drawback to this structure is that you are personally responsible for the company’s assets. Raising money through commercial lending may also be difficult. Savings, family loans, or a home equity line of credit may be the only way to fund the venture.

There are two types of partnerships: general partnerships and limited partnerships. In a general partnership all partners assume liability for debt and obligations. In a limited partnership, there is one general partner and limited partners who act as an investor. A general partnership would usually be your best bet unless you have multiple passive investors. One of the major advantages in forming a partnership is the tax advantages. The business does not pay tax on its income but instead “passes through” to the individual partners. The Form 1065 must be filed by the company and each partner must file a Schedule K-1. On the downside, each general partner is liable for the businesses debt. Also a partnership can be unappealing because one partner can make financial decisions for the whole business and you can become liable for these decisions.

Corporations are more complex and expensive than the majority of other business structures. On a positive side, a corporation structure tends to have less exposure to liability. The business is an independent legal entity, separate from its owner.  Therefore, your personal assets are not at risk if the business defaults. Another advantage is the opportunity to raise capital. Common or preferred stock can be sold to generate equity for the business to expand, promote, or whatever it is they may need. A disadvantage is the cost of organization. An attorney and accountant will be needed and the hours it takes to set-up a corporation may be costly.  Another drawback is double taxation, which is the corporation being subject to corporate tax (both federal and state tax) and also any dividends paid out are taxed.

Choosing the correct entity for your business does not have to be a huge hassle. Before choosing a structure you should consult with your attorney and accountant, regardless of what structure you are considering. For more information about business structures, check out the article at Entrepreneur Online.

Disclaimer: Note, neither Kutztown University Small Business Development Center nor Jump Start Incubator provide legal or tax advice and any information in this is blog is meant solely for information purposes. Kutztown University Small Business Development Center and Jump Start Incubator highly recommend that you contact a licensed practitioner when considering legal and tax issues.

Business Incubation Could be Exactly What Your Business Needs!

Entrepreneur online recently covered an article about business incubators. The emergence of business incubators has quickly taken North America by storm. They seem to be the craze that is attracting Universities, development groups, CEO’s, and technology labs to open and operate their own. Who would have thought that an 850,000-square-foot facility in New York has now transformed into a tremendous opportunity for small businesses and entrepreneurs? There are now over 1,000 incubators spread out through North America and they all share the same intention as the original; help small business grow and prosper. Whether your business: is a pre-venture, in the early stages, producing the new cutting-edge technology or a more traditional small business, a business incubator could be exactly what your small business needs. From financing help to general business assistance, these incubators are helping local economies develop.

Financing can be a key factor in the start-up or development of a business and where to find it can turn into a nightmare. In Seattle, two former Microsoft developers have opened up their own incubator and will invest up to $250,000 to promising and innovating software projects. Click the link for more information about this incubator and others.  Although most incubators are not handing out start-up cash, there are other ways that being in an incubator can help your small business find financing. Angel investors have found incubators to be a great spot to seek their next investment.  Many incubators built alliances with angel investors. The fact that many different businesses are all under the same roof is attractive to these angel investors. Incubators also have ties to economic-development groups, local banks, and microloan opportunities. All of which could be the answer to your financing question.

General business assistance or development assistance is a great service that incubators provide. Here at the Jump Start Incubator we have a team of consultants and MBA students that provide our on-campus clients with hands on training and business assistance. Incubators throughout North America are becoming very specific. If your company has a niche in biotech, solar power, vaccine development, or homeland security there is an incubator out there just for you. Whatever it is that your business is aiming to do, incubators can be a helpful tool along the way.

Incubators may not be the answer to every business out there but it could be the answer for yours. Businesses have gone from incubators to IPOs; your business could be next! For more information about business incubators, check out the full article at Entrepreneur online.