This is a question that you only have to answer once.  And you want to answer it correctly…once you pick a basis for your business, it is FOREVER.  That’s right.  Once you set up your company’s financial house you will never change this option.

What this means… when do you realize income and expenses?  A sale is made today.  If a business is on ACCRUAL basis the sale is realize today.  However, if we don’t realize the sale until it is actually paid for, that is CASH basis.

Okay, here is an example.  I make origami swans and I sell them in my awesome origami store.  On January 15th, a customer came in and bought $50 worth of swans.  I also sell them wholesale to an origami store in Texas.  They bought $300 worth of my paper creations but will not pay me until February 15th.  Since I am on an ACCRUAL basis, I have $350 in sales on January 15th.

Now, using the same dates and amounts…I sell $50 worth of swans on January 15th, and since it is a retail customer they pay me with cash that day in my store.  Then, I sell the $300 order of swans to the store in Texas.  I ship them and they pay me $300 as agreed on February 15th.  If I am on a CASH basis, my sales are $50 in January, and $300 for February.

Most businesses are going to be on an accrual basis.  A medical or dental office is a good example of a cash basis accounting business.  Why?  They are going to generate charges for a patient, but they must wait on insurance payments, make adjustments, collect the patient portion, possibly resubmit to insurance.  There can be a significant delay in reconcililing all the payments for a single event so a cash basis works better.

The industry you operate within will most likely dictate this decision.  You need to know this when you setup your accounting software from day one.  If you are really confused as to which is more appropriate, speak with your tax preparer or CPA.