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Monique DanaoSmall Business and Tech Writer
Monique Danao is a highly experienced journalist, editor, and copywriter with an extensive background in B2B SaaS technology. Her work has been published in Forbes Advisor, Decential, Canva, 99Designs, Social Media Today and the South China Morning Post. She has also pursued a Master of Design Research at York University in Toronto, Canada.
Kelly MainStaff Reviewer
Kelly Main is a Marketing Editor and Writer specializing in digital marketing, online advertising and web design and development. Before joining the team, she was a Content Producer at Fit Small Business where she served as an editor and strategist covering small business marketing content. She is a former Google Tech Entrepreneur and she holds an MSc in International Marketing from Edinburgh Napier University. Additionally, she is a Columnist at Inc. Magazine.
Monique Danao,
Monique DanaoSmall Business and Tech Writer
Monique Danao is a highly experienced journalist, editor, and copywriter with an extensive background in B2B SaaS technology. Her work has been published in Forbes Advisor, Decential, Canva, 99Designs, Social Media Today and the South China Morning Post. She has also pursued a Master of Design Research at York University in Toronto, Canada.
Kelly Main
Kelly MainStaff Reviewer
Kelly Main is a Marketing Editor and Writer specializing in digital marketing, online advertising and web design and development. Before joining the team, she was a Content Producer at Fit Small Business where she served as an editor and strategist covering small business marketing content. She is a former Google Tech Entrepreneur and she holds an MSc in International Marketing from Edinburgh Napier University. Additionally, she is a Columnist at Inc. Magazine.
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Brette Sember is a retired attorney who has been writing and editing law and legal topics for more than 25 years. She is the author of more than 40 books, is a nationally recognized expert on divorce and family law and has a depth of experience that include estates, probate, finance, business, bankruptcy and more. Her website is www.BretteSember.com.
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Brette Sember, J.D.
Brette Sember, J.D.contributor
Brette Sember is a retired attorney who has been writing and editing law and legal topics for more than 25 years. She is the author of more than 40 books, is a nationally recognized expert on divorce and family law and has a depth of experience that include estates, probate, finance, business, bankruptcy and more. Her website is www.BretteSember.com.
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Updated: Jan 24, 2023, 1:00pm
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Table of Contents
- What Are Accounting Methods?
- What Are The Different Types Of Accounting Methods?
- Method 1: Cash-Basis Accounting
- Method 2: Accrual Accounting
- Method 3: Modified Cash-Basis Accounting
- Choosing the Best Accounting Method for Your Business
- Frequently Asked Questions (FAQs)
Show more
Finding the ideal accounting method for your business can be difficult when you still need to learn the basics. The right accounting method will help you record financial transactions, so you can get an overview of your business’s health. Check out our guide below to learn the different types of accounting methods and find out which might be the best choice for you.
What Are Accounting Methods?
Accounting methods refer to the set of rules a business follows to keep track of financial transactions and financial records. Its main objective is to provide an accurate overview of an organization’s expenses and profits.
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Why Using the Right Account Method Is Important
Here are some of the reasons why choosing the right method is important:
- Determine financial health: Each accounting method offers various levels of perceived profitability in the short-term and long-term. Some methods give a status of your business’s current health based on current true income, while others provide a long-term overview of a business’ finances.
- Taxation purposes: Based on company type, you may be required to report finances using a specific accounting method.
- Financing purposes: The right accounting method can improve your chances when looking for debt financing and when being evaluated by investors or other financial institutions.
- Growth forecasting: The right accounting method will make it easier for you to forecast the future growth of your business based on your company’s size.
What Are The Different Types Of Accounting Methods?
Take a look at some of the common types of accounting methods you can choose from.
Method 1: Cash-Basis Accounting
Cash-basis accounting requires businesses to record cash, expenses and income. Keep in mind income is recorded once received and expenses are paid. If you have a long-term project, you won’t be able to record transactions until it is paid. Similarly, taxable income and expenses are reported in the year in which you get the compensation or pay the expense.
While this method gives an accurate overview of a business’ perceived income, it does not allow you to track loans, liabilities and inventory. It also does not give an accurate representation of your business’s status because you won’t be able to see unpaid transactions and expenses until the compensation is sent. Still, this method may be ideal for small businesses that want an accurate overview of their financial situation.
Take note that when a business achieves $26 million in average gross receipts over the past three years, it must shift to the accrual method based on IRS rules.
Use With: Single-Entry Accounting
Cash-basis accounting is used alongside single-entry accounting because they are both the simplest accounting methods. Incoming receipts and outgoing expenses are only recorded once.
Method 2: Accrual Accounting
Accrual accounting is a more complex accounting method that requires you to record incoming revenue and expenses—even if payment has not been made. This means expenses are recorded once the bill is received and income for a long-term contract is recorded when the deal is closed.
Unlike the straightforward cash-based accounting, accrual accounting also considers accounts payable, liabilities, assets and inventory.
From a business perspective, this method allows a business to record all incoming revenue and gives a better understanding of their profitability. It also makes it easy to create financial forecasts and estimate budgets. Since all incoming revenue is recorded, this also makes it easier for businesses to seek financing opportunities from banks and investors.
The accrual method is required for businesses with more than an average of $26 million in sales over the past three years. Use with: Double-Entry Accounting
When performing accrual accounting, a double-entry accounting system is highly recommended. Each transaction is classified as a debit and credit to different accounts which makes it more appropriate than a single-entry accounting method.
Method 3: Modified Cash-Basis Accounting
The modified cash-basis accounting method is a combination of cash and accrual accounting. All transactions and payments related to income and expenses are recorded once it occurs. Instead of choosing one accounting method, this type lets businesses record short and long-term transactions and get the best of both worlds.
Cash-basis accounting lets businesses use a mix of accounts such as cash, liabilities, assets and accounts payable.
Use with: Double-Entry Accounting
Much like accrual accounting, modified cash-basis accounting is used with double-entry accounting.
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Reg. Price: $15 per month; Special Offer: 75% off all plans for 3 months until February 13
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$15 per month (for the first 3-months, then $30 per month)
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Choosing the Best Accounting Method for Your Business
Each accounting method comes with pros and cons. The method you choose will impact how taxation is reported and your overview of your business’ financial situation.
If you’re a large and complex business, accrual accounting will give you a better understanding of your business’s revenue. For example, a marketing company may be paid periodically based on the percentage of work performed or compensation could wait until the entire project is completed. Financial institutions and investors may view this accounting method more favorably because it gives a better overview of its revenue and expenses in the long-term.
Cash accounting method is ideal for small businesses which prefer a straightforward way to measure income and expenses. However, revenue won’t appear on the ledger until the payment is received.
Nevertheless, businesses looking to combine the two methods can opt for modified cash-basis accounting. This allows them to view short-term cash transactions and long-term financial transactions related to their business.
Bottom Line
When choosing an accounting method, be sure to educate yourself on its implications. The ideal method should provide you with an understanding of your business’ financial health and transactions. To help make the process easier, businesses often choose to use accounting software. For more information, check out our guide on the best accounting software for small businesses.
Frequently Asked Questions (FAQs)
What are the three types of accounting methods?
The three types of accounting methods are cash-basis accounting, accrual accounting and modified cash-basis accounting.
Cash-basis accounting records income when received and transactions when paid. Accrual accounting records financial transactions even if they’re not paid yet. Meanwhile, modified cash-basis accounting is a mix of both.
What is the best method of accounting?
The best method of accounting will depend on your business’ size, financial situation and context. If you’re a large company, accrual accounting is more ideal because it provides an overview of all incoming revenue. In contrast, small businesses with simpler needs may prefer cash-basis accounting.
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