Cash is king for many tech companies, but this is especially true for startups. Deferral of income taxes frees up cash and makes it available for reinvestment. Maintaining a healthy reserve can be the difference between surviving and thriving, so why pay the government early? You need your accounting approach to meet your needs for liquidity.
Tech Industry Cash Flow: Cash vs. Accrual Method
Generally, tech companies must use accrual or cash method of accounting as their overall method of accounting.
Let’s say a company’s accounts receivable is greater than accounts payable (accrued expenses). The cash method grants them the ability to defer paying income taxes on the difference. It takes cash flow into consideration, allowing a company to pay tax on income when received, instead of when earned.
You’d report income in the year actually (constructively) received and deduct (capitalize) expenses in the year paid. Generally, you can do this if inventory is not an income-producing factor, or if its role is small compared to the services provided.
Under the accrual method, a company would report income in the year earned and deduct expenses in the year incurred. Unless you meet an exception, this method is required when you maintain inventory for production, purchase, or sale.
Companies can also elect to maintain their books using the accrual method of accounting, and use the cash method for tax purposes. The accrual method is often required by banks, as it can help companies verify their financial position.
Determining Factors for Utilizing the Cash Method
Many tech companies qualify for the cash method because of their business’s unique characteristics. Factors that determine whether to use cash or accrual-based accounting include:
– What a company produces or provides as a service,
– How they’re organized (entity type and organizational structure), and
– Gross revenues a company has received
What about exceptions? Here are some to avoid having to use the accrual method:
Review Your Method Annually
Remember, the longer a company can defer paying income taxes, the more cash they will have on hand to inject into the business. Many tech companies are eligible for the cash method of accounting and should review their situation each year to ensure that they are using the best method.
If you have any questions or would like ideas that could help improve your cash position and cash flow, you can contact Jared Weiskopf, Director in the business tax service area and the Practice Leader in state and local taxation today.
Jared is a Director in the business tax service area and the Practice Leader in state and local taxation. Jared assists clients with corporate and partnership tax preparation and planning and research. Jared has provided public accounting services since 1997.More posts by Jared Weiskopf
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