Record Keeping: Part II
Adequate and appropriate recordkeeping is essential for any business and non-profit organization. As an accountant, I am frequently asked questions about recordkeeping:
What records do I need if I were audited by the IRS? Why do I need to keep evidence of income and expenses? How do I know if my recordkeeping is appropriate?
Like everything else in business and life, there are a number of variables to consider when creating an adequate and appropriate recordkeeping system. An adequate recordkeeping system will substantiate your income and expenses when info is requested by the IRS. An appropriate recordkeeping system satisfies your management needs as an owner or non-profit director. In this blog series I have identified what I believe to be the main considerations when building an adequate and appropriate recordkeeping system. The focus target audience is a small-business owner however information provided here is still applicable to non-profit directors. Non-profits are subject to more specific reporting and compliance requirements that are not captured in this blog.
Part II: Management tracking and reporting
Management tracking and reporting goes beyond the ‘what is required’ and into the world of ‘what is useful’. Building and maintaining an appropriate recordkeeping system will allow you to track, analyze, and make informed decisions based on financial data to adequately run your business.
Many small businesses report taxes on the cash basis accounting method. In the cash basis accounting method, income is recorded when received and expenses are recorded when paid. The timing is determined when an item clears a bank account or credit card statement. At a minimum, a cash basis business needs to track cash-in and cash-out for reporting requirements. The cash basis recordkeeping system however is very limited because it does not track rights to receive money and obligations to pay money. These rights and obligations are captured when recorded in the accrual basis accounting method.
In the accrual basis accounting method, income is recorded when it is earned and expenses are recorded when incurred. For example, income is earned when you perform your services or sell your product. The revenue is recorded when you send an invoice to your customer. This event creates a receivable which is your claim to your customer’s money. When the customer makes a payment, say via a check, the check is deposited to your bank account and the receivable is eliminated. Same holds true for expenses, however you are obligated to pay your vendors when the vendor bills your business and the obligation is then eliminated when you pay the bill.
Recording on the accrual basis accounting method allows an owner to better project short-term cash flows. The accrual basis accounting method can provide reports itemizing customer balances and how many days each customer is past due. Also in the accrual method, a business can better track and leverage discounts provided by vendors, ultimately reducing money paid-out by a business.
Many businesses combine the cash basis and accrual basis accounting methods. Many businesses report taxes on the cash basis but leverage the tracking and reporting capabilities of the accrual basis. These owners often monitor their business throughout the year using the accrual method and then generate cash basis income statements when reporting annual taxes. Both systems run in unison, without interfering with each other, and satisfy the needs of both the IRS and ownership.