Guest Author - Mary Salzman

Customers are those individuals or businesses to whom your business sells goods or services. Those good that you sell can be inventoried raw materials that are further processed by your company into a product. Goods can also be finished items purchased from a wholesaler that your business marks up and sells to customers.

Services include any type of business for which the end product is more intellectual rather than a physical product. For example, consulting firms such as advertising agencies, doctors, dentists, attorneys and accountants.

To a certain degree businesses such as hair salons and day spas also fall into the service business category if the majority of their income is derived from the sale of services (cutting hair) as opposed to the sale of hair care products.

Clients often ask about the difference between operating under the accrual method of accounting and the cash method. Specifically, they want to know why it makes a difference when sales are booked when they occur as a customer invoice rather than just preparing a cash invoice when money changes hands.

When properly entered into an accrual accounting system, transactions with your customers affect the balances of the accounts receivable account and your revenue account. This means that customer invoices are recorded when they are earned and realizable regardless of whether any money changes hands.

When only cash invoices are prepared you are naturally existing in a cash based environment. Why is this not particularly good? Besides the fact that for tax treatment it might not be allowed, there is no matching of revenue and expense.

Non-service type businesses will not have an accurate snap shot of their business through either the income statement or balance sheet unless customer invoices are recorded contemporaneously. Why? Because there is no matching of revenue and expenses.

If you purchase and pay for the materials to do a job three months before the client pays you, your income statement will reflect overstated expenses in the first month and understated expenses in the third month. This also, gives you no basis upon which to gauge individual job productivity.

Straight up service type businesses can also have somewhat of a misallocation of revenue to expenses. However, in my experience net income will not be as dramatically affected. For this reason, most of my service type clients do use the cash method of accounting.