 Most of this information comes from the tax guide for small business for individuals who use schedule C publication 334 tax year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused online, one income. Remembering that the first half of the income tax formula is in essence an income statement. Although just an outline, just a scaffolding, other forms and reports flowing into it. For example, the schedule C, the business income, which is in essence an income statement, having income and expenses, otherwise known as business deductions, getting to the net income, that would flow into the top line, the income line of our income tax formula. This is page one of the form 1040. We're looking at line number eight. Schedule C would roll in and flow to schedule one, which would flow in and flow to the form 1040. Page one, line eight, we see here. Here's a schedule C profit or loss from business, where we have in essence and income statements, income minus expenses. That said, let's take a look at the cash method. So we talked about in prior presentation that it is important to get the correct method and period correct on your first reporting of a schedule C, because although you have some leeway to pick the method that you want, it is more difficult once picked to change accounting methods, because you would have to request from the IRS a change in accounting method. That is because the IRS wants consistency. So if you pick a cash-based method, they want you to stick with the cash-based method, because if they allowed you to change from a cash-based method to an accrual-based method, you can start to manipulate the cutoff dates, which would start to manipulate your taxes. So let's think about one of the major two methods here. We've got the cash-based, we've got the accrual-based. They aren't completely different or opposite types of methods, and you could have a combination between the two methods, using a component of a cash-based method, for example, on the expense side of things, whereas you use an accrual method on the revenue side of things. There are also some transactions where you could use either the cash method or the accrual method, and the transaction would basically be the same. So for example, if you were to pay for something and at the point in time that you got the services, so you went somewhere and you bought supplies, for example, and you're just gonna expense the supplies at the point in time that you purchased them, then you would, on a cash-based system, have a decrease to cash, and you would record the expense at the point in time you purchased the supplies, because that's the point in time that you paid the cash, but on an accrual-based system, if you consumed the supplies right after you purchased them, for example, you would also record an expense at the point in time you purchased the supplies, not because that's when you paid for them, but because that's when you consumed the supplies. So both methods would result in the same transaction happening at the same time. Oftentimes it's only when there's a difference in terms of time of purchase versus time of use. So for example, if you bought those supplies and then you didn't actually consume them until sometime in the future, then when you buy the supplies you should put them on the books as an asset and when you consume them, that's when you would basically expense them on an accrual based system. Okay, cash method. Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. So if you have a small business then the cash method is often an easier way to do the bookkeeping. And if you have accounting software for example, it's getting easier and easier oftentimes to basically construct your books from the actual bank information using like bank feeds and like a quick book software for example. However, it'll be industry specific in terms of how easy that's gonna be and whether you can completely do that. There are times when you have to deviate from a cash based system. So for example, you might say, hey look I'm just gonna try to record everything that hits my bank account, which is a business bank account as a cash based transaction. That means you're recording your information on a cash based system because you're recording transactions just when they hit your bank account, which is obviously a cash based type of thing. So that means when income goes into your bank account in a deposit, it would generally be revenue at that point. When expenses come out of your bank account it would generally be an expense at that point. That works most of the time but there are deviations for a type of business for example, that has to do the work first and bill the client. That means you have to deal with accounts receivable, tracking accounts receivable and collecting that adds an element of an accrual component making the accounting a little bit more difficult. If you're in a gig work situation where for example, you're just getting paid by like YouTube or something like that. Then you can use a cash based system quite easily but if you have to bill the client it's gonna be a little bit more difficult. If you have to deal with payroll the payroll is gonna deviate oftentimes from a strict cash based system where you can just take the information from the bank because you're gonna have to record withholdings and whatnot and deal with a whole payroll situation. If you have inventory, that's the classic one that pushes people from a cash based system oftentimes to an accrual based system because when you buy inventory if you're planning on selling it later typically you don't expense it at the point in time you buy it but rather put it on the books as an asset which is an accrual thing to do and then you're gonna expense it when you sell the inventory. So that said it will be dependent on the industry of course. However, if an inventory is necessary to account for your income you must generally use an accrual method of accounting for sales and purchases unless you are a small business taxpayer to find later in this chapter. So if you have inventory and you're saying I wanna do this as easy as possible I wanna be in a cash based system maybe if you're like a small business in certain situations but you have to be careful there because inventory is the classic area where the IRS is gonna say if you're under certain circumstances we want you to track the inventory which again is an inherently accrual thing if you're tracking inventory as an asset. So for more information you can see inventory later so income. So under the cash method include in your gross income all items of income you actually and constructively receive during your tax year if you receive property or services you must include their fair market value in income. So on a cash based type of system note that the difference between these two systems are usually timing differences. So if you're in a cash based system you're not gonna record the income until you do the work. Now again if you did the work and you got paid at the same point in time like you have a restaurant for example you gave someone food and they paid you at the same point in time. Well then either a cash or accrual method will record the same transaction although for different reasons. A cash method because that's when you got paid and accrual method because that's when you did the work that's when you record revenue when you did the work. But if you're in a system where basically you have to do the work first and then you're gonna get paid at a later point in time then on that system when you did the work that's when you would record the revenue because there's a timing difference even though you didn't get paid yet. But then when you got paid then under an accrual method that's not when you would record revenue because you already recorded it for you would just decrease the accounts receivable on a cash method you wouldn't record it until you actually got the income is the general idea. Now also note that just because it's called a cash method doesn't mean you can avoid income taxes by having a barter a trade situation. So if someone pays you in services you give them food from the restaurant and they give you services for whatever their business is that's still income and you have to record it on a cash based system when you got paid even though it's not gonna hit your income account. So example on December 30th, 2021 a client sent you a check for interior decorating services you provided to them. So now it's at the cutoff they sent you a check on December 30th. So now we're talking about well that's close to the end of the year. Did I get the check? When do I have to include it in cash? So you receive the check on January 4th, 2022 you must include the amount of the check in income in 2022. Why? Because you didn't actually get the check until 2022 even though they wrote the check in December 31st, 2021. Now that's a different situation if it was actually in the mail then you receiving the check putting it in a drawer and holding on to it for like a month or something like that because you don't wanna record it as income until January in the next year. That's a different situation, right?