Accounting Methods For Your LLC
Keeping up with your accounting is an important part of any business. Your LLC cannot thrive if you don’t have a solid method to track your income and expenses. The two principal methods are the cash method and the accrual method (sometimes called cash basis and accrual basis). Before you can choose the right method for your LLC, you should know the advantages and disadvantages of both. The two methods don’t change your income or your expenses, just the timing on when they are credited and debited to your accounts.
The cash method is the method used more commonly by small businesses like your LLC. If your limited liability company uses the cash method you will not count income until you have received the actual cash or check, and you will not count expenses until they are paid.
If you opt to use the accrual method when you form an LLC, you will record entries a bit differently. Using the accrual method, income is counted when you make the sale and your expenses are recorded when you receive goods or services. You are not waiting until you receive or make payment before recording the transaction. Let’s take a look at a couple of examples.
Income. Your landscaping LLC completes a job in June but the client does not send you a check until September. Under the accrual method you would record the income in June. But, with the cash method, you would not record the income until you received payment in September.
Expenses. You purchase a new computer for your LLC in March and pay for it in May. Under the accrual method you record the expense in March when you took possession of the computer. If your business uses the cash method you would record the expense when you make the payment in May.
If you choose the accrual method for your LLC how do you determine the transaction date? It can be difficult if the sale occurs on one date but it takes time to complete the job. You record income when you complete the service or deliver all the goods. The same applies for expenses. You record the expense once the service has been completed or all goods have been received and installed, if necessary.
If your LLC (or corporation) has sales of less than $5 million per year, you can choose to practice either accounting method. However, you must use the accrual method if:
• You have sales greater than $5 million per year
• You stock inventory that you will sell to the public and your gross receipts are greater than $1 million per year.
There are advantages and disadvantages to both methods. The accrual method is great for a big picture view of income and debts but could mask a cash flow problem. In reverse, if your LLC uses the cash method you may have a good accounting of cash on hand but you have to be cautious of painting a misleading picture of your long term profitability.
Your taxes are impacted based on which method your LLC uses. If you incur expenses in one year but do not pay them until the next year, under the cash method you would have to wait until the year you paid the expense to take the deduction. If your limited liability company opts to use the accrual method, you could claim the deduction in the same year you incurred the expense even if you do not pay the expense until the following year.
