Cash is king for many technology companies, especially start-ups. Generally, the longer a company can defer paying income taxes, the more cash they have available to grow the business—and maintaining a healthy level of cash can be the difference between thriving and surviving. Utilizing the right method of accounting may allow companies to keep more cash in their pocket and improve cash flow, providing an opportunity to put it to work instead of paying the government early.
Improving Cash Flow: Cash Method vs. Accrual Method
The two available accounting strategies are known as the cash method of accounting (cash method) and the accrual method of accounting (accrual method).
The cash method allows companies with accounts receivable in excess of accounts payable (or accrued expenses) the ability to defer paying income taxes on the difference. The cash method takes cash flow into consideration, allowing companies to be taxed on income when received, instead of when earned. In essence, income is reported in the year actually, or constructively, received and
expenses are deducted or capitalized in the year paid. The cash method is generally allowed where inventory is not an income-producing factor or is small in relation to the service provided.
This is in contrast to the accrual method where income is reported in the year earned and expenses are either deducted or capitalized in the year incurred. The accrual method is required when a company maintains inventory—either for production, purchase, or sale—unless an exception applies. Companies can still maintain their books using the accrual method of accounting, and use the cash method for tax purposes. The accrual method can help companies more accurately track their financial position, and banks may require its use as well.
Determining Factors for Utilizing the Cash Method
Although not all companies have the ability to use the cash method, many technology companies do qualify because of their business’s unique characteristics. What a company produces or provides as a service, how they’re organized (entity type and organizational structure), and gross revenue become factors in determining whether they can use the cash method or are required to use the accrual method for tax purposes.
Once a company chooses a method of accounting, they can generally change that method if they qualify or meet one of the following exceptions to using the accrual method.
Review Your Methodology Annually
Remember, the longer a company can defer paying income taxes, the more cash they have available to grow the business. Many technology companies are eligible to use the cash method of accounting, but should review their situation annually to ensure the best and most advantageous method is being used to improve their cash flow.
If you have any questions or would like ideas that could help improve your cash position and cash flow, contact Jared Weiskopf at 651-407-5830 or firstname.lastname@example.org.