What’s the Best Accounting Method for Your LLC?

As your LLC invests in its operations, it must track these expenses with accounting methods. The best one for your business impacts crucial aspects of its operations, including the company’s bookkeeping process, tax obligations, and long-term growth.

An LLC accounting method describes how your venture reports its profits and expenses. LLCs can use one of two main accounting methods, namely accrual and cash accounting. There are several differences between these methods, which we’ll discuss below.

Key Takeaways

• In cash accounting, you record transactions when you spend or get cash. Accrual accounting entails recording transactions when they’re incurred.
• New LLCs can benefit from cash accounting due to its simplicity and potentially positive impact on their tax burden.
• Accrual accounting gives you better financial insights. However, you can only use it if your LLC’s average annual gross receipts have exceeded $25 million for the past three years.
• Your LLC may also need to work with a trusted accountant if it’s required to use accrual accounting.
• While you can change your accounting method, the IRS must approve it. You can request this by filing IRS Form 3115 (Application for Change in Accounting Method).

How Does Cash Accounting for LLCs Work?

Cash accounting involves recording transactions whenever money is spent or received. Once your LLC gets paid from sales or for its services, that’s when you record its income. Similarly, your business expenses are recorded when your LLC’s bills are paid.

What are the Advantages of Cash Accounting?

Since you only record transactions when making or receiving payments, you’ll find cash accounting easy to do. And unlike other accounting systems, you only track one account and just leave double-entry bookkeeping to the experts.

Cash accounting also shows you how much money your LLC has on hand. Overall, you can manage your expenses better and see whether your venture has been profitable.

Finally, using cash accounting could mean simpler business tax returns. Again, you just record your LLC’s profits and expenses when they’re remitted to your account. You can determine when to pay large amounts of cash as a result, potentially making your tax burden more manageable throughout your current tax year.

Related Resource

Learn how to file business taxes for an LLC here.

What are the Disadvantages of Cash Accounting?

Although cash accounting is straightforward, it has notable limitations.

• Cash accounting only covers transactions made during a specific period, excluding account liabilities and receivables. Hence, assessing your LLC’s overall financial health becomes challenging.
• Larger LLCs shouldn’t use cash accounting if they:
  • Offer credit to customers.
  • Maintain a product inventory.
  • Generate over $25 million in average annual gross receipts for the previous three years. In this case, you must use accrual accounting.

How Does Accrual Accounting for LLCs Work?

In accrual accounting, you record transactions that your LLC incurs.

Suppose a client would only pay your business for its services after 30 days. You can record the upcoming payment while waiting for it. Similarly, when you receive supplies with payment terms, the expense is recorded upon receipt.

What are the Advantages of Accrual Accounting?

Unlike cash accounting, accrual accounting lets you see your LLC’s overall financial health. It includes receivables and liabilities that cash accounting disregards. Ultimately, you know how profitable your business is.

If your LLC needs significant investments, applies for business loans, or plans for rapid growth, accrual accounting gives you the detailed financial insights stakeholders expect. Plus, large businesses with complex operations (including high-income LLCs) must use accrual accounting.

What are the Disadvantages of Accrual Accounting?

Accrual accounting is more complicated than cash accounting, as you must track multiple accounts for proper expense tracking. The best accounting software solutions make this task easier.

Furthermore, using this accounting method may require a trusted accountant’s expertise and an automation system. Accrual accounting doesn’t detail your LLC’s cash flow, either. While you can record unpaid income, it might not enter your account immediately.

Related Resource

Get a quick guide to commonly used accounting methods from NCH’s Small Business Tax Tip series.

What to Consider When Choosing an Accounting Method

Several factors determine your choice of accounting method, including:

Tax & Regulatory Requirements

Businesses must follow current tax and regulatory requirements when using their chosen accounting method. We’ve already mentioned that you can only use accrual accounting if your LLC’s average yearly gross receipts for the last three years exceed $25 million. The rule applies to LLCs taxed as corporations and partnerships, although those treated as S corporations are exempted.

Additionally, LLCs operating as tax shelters under Section 448(d)(3) of the Internal Revenue Code must use the accrual method instead of cash accounting.

Your LLC’s Size & Future Growth

If you’re a new LLC, consider using cash accounting. Small businesses find this method easier to understand and maintain.

On the other hand, high-income LLCs and those with complex operations use accrual accounting for a more detailed look at their financial health.

Your Specific Industry

Another factor to consider when choosing the best LLC accounting method is whether you’re maintaining inventory.

Cash accounting works for LLCs with little to no inventory, including service providers and professional LLCs. This method doesn’t require matching inventory costs to revenues. But if your business maintains inventory, use accrual accounting. You’ll need it to determine the value of the entire inventory and match them with revenues generated in the same period.

Other Factors

In addition to the aforementioned factors, the following determines your choice of accounting method.

• Your need for external funding and investors – You’d want a reliable and GAAP-compliant accounting method if you’re seeking financing. In this case, accrual accounting stands as your best option.
• How complex your transactions are – Simpler transactions require cash accounting, while more complicated transactions need accrual accounting.
• Your tax planning needs – LLCs with revenues lower than the standard threshold may need to use cash accounting instead of accrual accounting. Conversely, high-income LLCs must use accrual accounting.

Can You Change Your LLC’s Accounting Method?

You can change your LLC’s accounting method, but it must be approved by the IRS. If you want to switch to another accounting method or use a different method for the accounting of a specific item, you must file IRS Form 3115.

Business owners usually complete and file Form 3115 for a requested change to their accounting method. Several types of businesses may need to do this, including partnerships and S corporations.

Nonetheless, changing your LLC’s accounting method requires careful planning and expert assistance. This decision will affect your current business bookkeeping and tax preparation processes.

Frequently Asked Questions

What is the difference between cash & accrual accounting?

Cash accounting involves recording income when payment is received and expenses when bills are paid. Meanwhile, accrual accounting entails recording when transactions are incurred, regardless of when your LLC is paid.

Can I change my LLC’s accounting method after filing taxes?

Yes, you can change your LLC’s accounting method after filing taxes. However, the IRS must approve it. You must file IRS Form 3115 to request a change in your current accounting method.

Take note that switching to another accounting method may affect your taxes. Talk to a trusted tax advisor before you make the change.

Does my LLC’s size determine its choice of accounting method?

Yes, your LLC’s size determines its choice of accounting method.

If your business generates over $25 million in average annual gross receipts for the past three years, it must use accrual accounting. Otherwise, you can use cash accounting.

Which accounting method is better for LLC tax planning?

Cash accounting is generally better for LLC tax planning because you can pay large amounts of cash whenever you want. This way, you can reduce your tax burden.

Conversely, accrual accounting requires tracking multiple accounts. A trusted accountant can help you with this task to avoid potential tax-related issues.

What costs more to use: cash or accrual accounting?

Accrual accounting costs more to use since it’s more complex than cash accounting. Furthermore, you may need a professional bookkeeper’s help to use it. Cash accounting will cost you less because of its simplicity.

Which accounting method should service-based LLCs use?

If service-based LLCs don’t maintain inventory, they should use cash accounting. These businesses can switch to accrual accounting when their average annual gross receipts exceed $25 million.

Can my LLC use both cash & accrual accounting?

Yes, your LLC can use both cash and accrual accounting if it meets IRS requirements. In this case, the business must use these methods properly. Failing to do so can result in penalties.

How does inventory determine my LLC’s choice of accounting method?

If your LLC maintains inventory, it must use accrual accounting to match its income to specified expenses. Cash accounting is ideal for LLCs with little to no inventory because they don’t need to match their income to business expenses.

Which method should I use for seeking financing & investors?

You should use accrual accounting for seeking financing and investors. That’s because it gives lenders and investors a clearer picture of your LLC’s profitability and obligations. Plus, accrual accounting can be used to determine an LLC’s value for its potential sale.

Can my LLC use one accounting method for taxes & another for internal reporting?

In some cases, your LLC can use one accounting method for taxes and another for internal reporting. You must reconcile your financial records carefully, though.

This approach makes bookkeeping more complicated and costlier. We recommend seeking expert advice to avoid inconsistencies or non-compliance with IRS regulations.

Expert Tips From NCH

1. Determine how long customers or clients take to pay your LLC. If they pay immediately, use cash accounting. Otherwise, use accrual accounting.
2. Monitor your gross receipts to see whether you’ve exceeded the $25 million threshold for average annual gross receipts. It’ll also help you plan a potential switch to a different accounting method.
3. Invest in accounting software that can handle cash and accrual accounting. Overall, it allows you to change your LLC’s accounting method as it grows.
4. Consult a tax professional before changing accounting methods. They can help you file IRS Form 3115 for your request, avoid non-compliance, and prepare for significant tax implications.
5. Assess whether your LLC can use its preferred accounting method as it grows. From there, you can choose to change it or not.

Keep Your LLC Financially Healthy with Proper Accounting

LLCs can use cash or accrual accounting to track their income and expenses. However, choosing the best method for your business is challenging. After all, it significantly affects your business bookkeeping process, tax liabilities, and financial and exit strategies.

Can’t choose between cash or accrual accounting? NCH’s accounting experts are here to help you make the right decision.

Contact Our Accounting Experts Today

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.