Accounting Methods
There are a variety ways to account for transactions. The most popular method for most small business owners is the cash basis. Quite simply, revenue is recognized for book and tax purposes when it is received (regardless of when billed), and expenses are recognized when paid (regardless of when incurred).

The method encouraged by the accounting profession (and used by virtually all large businesses) is the accrual method of accounting. Revenue is recorded when billed (regardless of when received) and expenses are reflected when incurred (regardless of when paid). Let's illustrate the difference between cash and accrual. Say you bill a customer for an item in December (the last month of your year), and the customer pays in January. On the cash basis, you have no income from this transaction until next year when you have the cash to pay the tax. On the accrual basis you would include this billing in this year's taxable income, even though you did not receive the cash to pay the related tax this year.

Since you can always pay bills to get a cash basis deduction, the cash basis provides more control over the timing of taxable income for small businesses. It also more accurately reflects the way most business owners run their businesses - based upon cash flow. An old small business saying goes: "Cash is King." So while revenue and expenses may swing wildly and don't necessarily match revenue with the related costs to generate that revenue (especially on job costing), most small business owners are more comfortable with a cash basis of accounting.

The cash basis tends to generate lower tax bills. In fact, the IRS will force you onto the accrual basis if you have high enough revenues or if inventory is a significant amount compared to cost of goods sold. But it requires special permission from the IRS to switch back to a cash basis of accounting.

There are many hybrid methods of accounting. The most popular is the income tax basis of accounting, which is simply the cash basis modified to fit the quirks of the federal income tax code (mostly related to depreciation and installment sales).

Utilizing Accountants
A common myth among small business owners is that buying a cheap, off-the-shelf software package will eliminate the need for an accountant or bookkeeper. The problem with this is that the software packages usually assume the user has a knowledge of accounting principles. The software will not think for itself.

Also, the time involved in entering data into a software package (not to mention the time involved in learning the package and all related annual updates) can take away from making sales. For a large number of very small businesses a manual system is actually less time consuming and more efficient.

When should you use a computer with an accounting package? If you have a large number of receivables (and perhaps payables) to keep track of, an accounting package can be very helpful. Also, job costing is often more effectively done on either a spread sheet or in a simple accounting package.

There are several types of service providers in the field of accounting. A bookkeeper or bookkeeping service will compile the general ledger and generate monthly, quarterly or annual financial statements. Payroll services are a specialized area. There are a number of good payroll services that will do everything from producing weekly pay checks and tax deposits to quarterly tax returns and year end filings. Payroll processing can be found from payroll services, some bookkeepers, some accountants, and even some CPAs. The next level up in sophistication is an accountant. Some accountants are very knowledgeable, while some have not kept up with the latest tax and accountancy changes. Accountants usually do not have special licensing requirements. One special example of accountants are enrolled agents (those who have passed an exam given by the IRS and admitted to practice before the IRS). CPAs (certified public accountants) are accountants who have passed a rigorous exam and have met extensive experience requirements. They must keep abreast of current tax and accounting changes to maintain their licenses.

Most small businesses need a bookkeeper (or just a part-time secretary) to perform much of the basic recordkeeping. Tax returns should be done by an accountant or CPA. If the bank wants a higher level of assurance on your financial statements, only the CPA can certify your statements. Obviously, the higher the level of service, the higher the price. Also, you may find that contracting with outside firms is lower cost than hiring an employee to do it for you.