Before you get started balancing your books, you first need to decide what type of accounting system you’re going to use: cash accounting or accrual accounting. The type of system you decide on will determine the financial statements and tools you need to manage your small business.
A cash accounting system tracks cash flow as it enters and leaves your business in real time. Under this method, accounts receivable and accounts payable aren’t recorded because they represent future transactions. With cash accounting, financial professionals will use a cash flow statement to record the financial health of your business over a certain period of time — whether a quarter or a year.
If your company uses accrual accounting instead of a cash flow statement, you will use a profit and loss statement (P&L) — also known as an income statement — to track your small business’s financial health. This document tracks things like a company’s revenue, expenditures, cost of goods sold (COGS), gross margin, and profit.
A P&L statement also lists all the accounts payable and accounts receivable for your business. As a result, it gives you the opportunity to review your company’s net income, which is essential for making sound business decisions.
Whether you use cash accounting or accrual accounting, there is one financial document every small business needs to succeed: a balance sheet . While a cash flow statement examines the flow of cash in and out of your business, and a P&L statement documents sales and expenses during a specific time, the balance sheet provides you with your company’s net worth.