Bookkeeping is much more than a function of tax return preparation. When done correctly, it informs you about the health of your business and helps you identify strengths and weaknesses. As a small business owner, you may be tempted to rely on the income numbers calculated by your tax return preparer. But beware – these numbers do not follow GAAP (Generally Accepted Accounting Principles) and will not present the picture that you are looking for!
How are tax returns prepared?
Tax returns are prepared using cash basis accounting. Income is earned when cash is received and expenses are incurred when cash is spent. Let’s say you made a large sale with 30 day terms in December 2015.
You paid salaries and purchased supplies/inventory in November and December. Your customer paid you in January 2016. Under cash basis accounting, your 2015 income reflects the expenses incurred on this sale, but the revenues are recognized in 2016. To the extent that this sale is material to your operations, and if you are relying on the income numbers recorded on your tax return, you would believe that your business underperformed in 2015 and overperformed in 2016.
What is GAAP?
The principles of GAAP are the standards and conventions used in the US to provide uniformity in accounting and financial statements. In addition to giving you a more accurate understanding of your net income (read on), GAAP financial statements are likely to be required by lenders and investors.
GAAP requires the use of accrual basis accounting, which recognizes revenues when they are earned. Using accrual basis accounting for the example discussed above, the revenues generated by the sale in 2015 would be recorded in 2015, giving you, the business owner, a true picture of your operations.
In summary, there are benefits to cash basis accounting. It is simple, straightforward, and represents your cash flows. However, for a broader understanding of your business, and for financial statements that are prepared in accordance with GAAP, you will want to produce accrual basis statements as well.
For more information on how we can assist you with your accrual basis statements, contact us today!