Did you begin your company as a sole proprietorship or a micro-business? When you first started your company, if you started small, you may have used cash-based accounting and it probably worked out fine for you.
In cash basis accounting, income is logged when it is received, and expenses are logged as they are spent, therefore they are deducted in that quarter, too. This can cause big problems for bigger businesses, though, for a few reasons.
1. Cash basis accounting can lead to a large tax liability in one quarter if a big job or jobs is paid upfront. The company might make expenditures in order to reduce tax liability, and then find itself coming up short when revenue is required to complete a job paid in a previous quarter.
2. Cash basis accounting is not GAAP compliant. The Generally Accepted Accounting Principles are “generally accepted” for a reason. If you hope to grow your company through venture capital, angel investors, or loans, investors and lenders will want to see your books. And they’ll expect them to follow GAAP so they are easier to understand.
3. If you ever get audited by the IRS, cash basis accounting, again, because it is not GAAP compliant, can get you into a lot of trouble… and owing big bucks.
As your accounting needs shift from the very basics of cash-based accounting to more sophisticated accrual basis accounting methods, online accounting solutions like a virtual bookkeeping staff from AccountingDepartment.com can help. Contact us today for more information.