Which Accounting Method Should You Use for Your Small Business
The end of the year is coming up and my wife has a big accounting decision to make. This year, my wife started a music studio. Since it’s her first year of operation, she has to pick an accounting method to properly report the taxes owed from the business.
Perhaps you’ve never given your choices much thought. Maybe you were not aware that there are different methods of accounting, but the choices available can greatly change your tax liability.
Two Different Accounting Methods
If you are a giant corporation, there are no options for you. You must use accrual based accounting. It’s not the same for small businesses like my wife’s studio. She is allowed to use either cash or accrual accounting.
Cash accounting is most popular, because most small business owners are everyday people. The method works a lot like keeping a check register. Every time someone hands you cash, you recognize that you’ve made a sale and every time you pay a bill, you recognize that an expense has been incurred. That’s why it’s called cash accounting. The mere movement of cash triggers your accounting to recognize profit and loss.
Accrual accounting is completely different. Recognizing a sale or an expense has nothing to do with paying out or receiving cash. Instead, it is based on the nature and timing of the business transaction. Sales are recognized when earned and costs are expensed when they are incurred. It’s not enough to collect money from a customer, if you haven’t fully delivered the product or performed the service; then you haven’t really made a sale yet.
How These Accounting Methods Work in Real Life
My wife bills her lessons quarterly. Since her business is based on appointments, this keeps her income steady and helps prevent people from missing appointments. However, it does create a big difference for her taxes this year.
Soon she’ll be collecting money for the next 12 weeks from 4 of her students. Based on the cash accounting method, all of the money she receives is taxable this year. It doesn’t matter, that only one of the 12 lessons being paid will be in December.
The accrual based method treats the situation very differently. Even though my wife is collecting a large check, the accrual method allows her to only recognize the sale of the one lesson she’ll perform before the month’s end. The revenue from the rest of the 11 lessons won’t be recognized and taxed until next year.
Which is the Best Accounting Method for My Wife?
It’s hard to say which method is the best for my wife. Since my wife started her business in September, She has the option of accelerating or deferring a large portion of her tax liability. Most tax professionals advocate that the default position should be to defer your taxes. However, my wife hasn’t earned a full year of taxes this year. It might make sense to keep next year’s tax liability smaller by selecting the cash based method.
Whatever she chooses, she’s going to have to live with her decision. You aren’t allowed to change accounting methods every year. Once she’s picked a method, she’ll need to stick to it going forward. However, the choice can have significant consequences on this year’s tax bill.
Thinking of opening your own business? Here’s some advice before learning to account.
Owning and accounting a small business is not for the faint at heart, but that’s likely what attracted you to the idea in the first place. If you think you have the chops of a true entrepreneur, now is one of the best times on record to realize your dreams; mortgage rates are low, the atmosphere is rife with creativity, and new modes of digital communication are making it even easier to connect with people. Here’s how you can harness all of that opportunity create a successful business.
Rewrite your business plan
After slaving away at composing a business plan, many entrepreneurs are just happy to have it done. But don’t put away that drawing board just yet. Some of the most successful business people will tell you that they had no idea what they were doing when they wrote their first business plan, despite hours of research and crunching numbers on the mortgage calculator, for instance. This isn’t to say that the entire thing needs an overhaul, but you should be open to re-tweaking it once you find out which aspects won’t work.
Talk to someone who has failed many times
Why would you waste time talking to someone who wasn’t successful his or her first time out of the gate? Because they know exactly what not to do. Take advantage of the chance to learn from someone else’s mistakes before they become your own. A good mentor can make or break your entrepreneurial experience by providing you with a bottomless source of business knowledge.
Build your business around your best customer
What kind of customer do you want to attract? This should be the driving force behind all of your business decisions, from where you decide to open up shop to what kind of packaging you will use for your products or services. And don’t forget about the all-important marketing mix; here’s one instance where the medium is truly as important as the message, so go where your potential customers are congregating to spread the news of your opening.
Surround yourself with a team who “gets it”
Contrary to what popular culture repeatedly affirms, being an entrepreneur is not a one-man (or one-woman) show. If you want a successful business, you will need to surround yourself with people who are not just talented at what they do, but also as passionate as you are about the product or service that you are providing. And then, once you have established trust, you can foster this passion and boost your business by letting them take the reins.
Take advice from your critics
There’s a lot to be said for not letting the naysayers spoil your entrepreneurial dreams. But this doesn’t mean that their input isn’t valid in some way. Make a game out of meeting your challengers’ responses to your business idea with creative and positive solutions. This will be the ultimate preparation for opening day.
Traits of a Well Accounted Business
If you are looking to start your own business, you are probably wondering what you can do to ensure that it is a success. Hundreds of books have been written about this very topic and it seems that everyone has their own idea on what it takes to be a successful business. Yet, times have changed and are constantly changing. What a business needed years ago will no longer fully apply to a business today. Technology and the market has changed drastically in the past years. A profitable business needs to adapt to fit the current market demands in order to appeal to customers. Here are several traits of a successful business in the 21st century.
Multiple Forms of Payment – Any business that relies solely on cash will be limited in its appeal to customers. Any business that hopes to hav ea sizable client base should have a credit card processing account in order to accommodate to the demands of the customer. After all, if you are unable to keep the client happy, it’s likely that they won’t return.
Quality Assurance – Public reviews are much easier to access these days than ever before. While one negative customer experience may not have significantly affected your revenue 5-10 years ago, it has the potential to do damage. In order to increase your client base, you need to please each and every customer. It’s as simple as that. If you don’t work to keep a positive rapport with your clients, you will have very few referrals and client growth will be slow at best.
Competitive Pricing – Again, public knowledge is higher than it has ever been. Between that and large corporations, competitive pricing is more important than ever before. If you think you can compete with prices that are higher than the market average, you will be quite surprised. It is necessary to follow the trends of supply and demand closely to find the optimal price for your product or service.
Management vs Marketing: This is How to Account a Small Business
I caught a very impressive interview on CNBC today with small business owner Bill Dieruf of Dieruf Hardware. His message was fairly simple, but highly effective:
Know the difference between management, and marketing.
You might have noticed over the last year that many major brand names are advertising for the sake of advertising, or just to remind you they’re still in business. Notable examples would be:
General Motors. We’re the new GM, the reinvented GM, and we’re getting down to business. (Same ol’ tired storyline of reinvention.)
Bank of America. This is America, and no matter what, we keep moving forward. (So what happens when you come to a cliff? Keep on going?)
Any generic bank commercial. I’ve heard the phrase “We are well capitalized!” from at least half a dozen different banking institutions since the 2008 stock market crash. If your best selling point is that you actually have money in your vaults, then it’s probably better to keep quiet and not remind everyone how bad your business is actually doing.
The point being, there is a distinct difference between spending money on marketing and throwing money away on marketing. Making a 30 second commercial with football players catching a touchdown passes and flashing your corporate logo at the end simply doesn’t cut it anymore.
Highlights from Mr. Diefur’s CNBC interview:
Dieruf Hardware has increased net profits for 63 consecutive years.
Maximizing management techniques rather than marketing techniques.
Know how to use financial indicators to predict/extrapolate future economic distress (e.g. a jump in credit card purchases).
Eliminated segments of the business that weren’t vital or profitable.
Embrace competition – the more competition you have, the sharper you keep your tools.
A business is a 100 percent entity. If you increase one segment of the business (e.g. advertising), you must decrease another segment of the business. Don’t breach the 100% ceiling or you might not be in business next year.
Very impressive interview, and I’m hoping his message will yield some positive returns for anyone who views it. (And reduces the number of crappy advertisements I’ve been flipping through over the last year).
Should You Do Business With Unethical Companies?
Maybe I’ve had some sort of “Come to Jesus” moment, but this recession thing has really opened my eyes to companies with poor business ethics.
Whether it be carelessness, blissful ignorance or a seemingly infinite supply of tolerance, we consumers seem to take our hard knocks from shady companies in stride. It’s almost like we expect to be screwed over since it is common knowledge that nearly transaction we make, someone on the other end is trying to make as much profit from that transaction as possible.
Yet, for some reason, we just keep letting them hit the Screw You Economics button since that has become the new American way.
We know it’s coming, so let’s get it over with as quick as possible so we can go back to our own place, shower up and wash the after-transaction smell away like a bad one night stand.
No More Business for Bad Business Ethics
Sure it sounds like a jaded rant, but if you have been screwed over by a company, don’t you feel a little angry? Would you — should you — continue to do business with them?
After all, it’s your money they are trying to take away from you.
Let’s try a few examples:
You Recently Bought a Pontiac Because You Wanted to Buy American. Nothing wrong with loving your country and wanting profits to stay on your native soil. But now that GM has killed off Pontiac, the cost of replacement parts will shoot higher as supply dwindles. If you keep it long enough, you might just be reliving an episode of The Dukes of Hazard by rummaging through junkyards for spare parts since they will become a rare commodity. Are you now feeling like you’ve been duped? Will other brands like Saturn follow suit?
You have Auto Insurance with AIG. After the government bailout, were you worried about not being covered? Were you ashamed to do business with poster child of the financial collapse? Worse yet, if you got in an accident, what would someone think if they saw AIG on your insurance card just days after the bailout and bankruptcy was a legitimate possibility? If I were the opposing driver, I would have probably been a little more worried.
You have a Mortgage with Countrywide (Bank of America). If you were one of the many homeowners who bought a home with a mortgage from Countrywide, does it bother you that a substantial proportion of their loans have resulted in foreclosure? Is it disheartening to know that the profits made from your mortgage could be going to the same business executives that helped cause the financial crisis of 2008?
You Use Time Warner High Speed Internet. Everyone loves a high speed internet connection, but would you be willing to say goodbye when your local cable monopoly charges you for gigabytes of information just like a cellular company charges you for your minutes so you will buy cable TV to stop you from watching TV online for free? Does it bother you that you’re doing business with an organization that lobbies state legislatures that a faster, cheaper and overall better municipal internet provider (Town of Wilson, NC) is a danger to their own monopoly and should be outlawed?
I suppose none of this really matters if you’re not the type to let a few dollars here and a few more dollars there get to you. If you are, I occasionally envy you.
Then again, $15 here and $20 there adds up to $35 at the end of the month. Annually that comes to $420 for your household to companies you may not think too highly of.
If you scale up the example to everyone on your street, that adds up to $42,000 (100 people x $420). Scale it up again to everyone in your town. Your city. Your county. Big numbers right?
Now do you see why it irks me?
So take a look at your budget, ask yourself who you’re doing business with. Are you happy with their services and their business practices? If not, maybe it’s time to do a little shopping around for an equivalent service elsewhere.