We’re not into tax season yet. That usually starts in about a week or so. I’ve been doing this now for over 25 years and every year, there is one question that I ALWAYS know I’ll get. “How can I possibly owe tax when I don’t have any money in my checking account?
It’s got to be one of the hardest phone calls you’ll get about your taxes. Well, other than “you’re being audited”. That’s a tough call too. In this case, though, you’re told that you owe a bunch of taxes and there is no money in your checking account.
Other than the first moment of panic you feel, you’ll probably feel annoyed with your accountant. Why didn’t he tell you sooner? That’s a big part of why we do NOT just prepare tax returns. We have year-round unlimited consulting. We want to stay in touch with you to find out what’s going on, to review and analyze your investments along with you and to project how much in taxes you’re going to pay.
And once you’re through the panic and the anger, the next feeling is probably confusion. If you’re a cash basis tax payer, how come cash doesn’t equal net income? If the money is all gone, spent legally on things for the business, won’t that mean there is no tax?
And that’s where the line gets a little fuzzy on what it actually means to be cash basis. In fact, most people think that there are two ways to report your income and expenses through your business: as a cash basis taxpayer or as an accrual basis taxpayer. Most businesses are neither. They are “hybrid” basis. That means that in some cases you are cash basis and in some cases you are accrual. For example, inventory that you purchase is an asset for your company. That means you’ll spend cash, but you don’t get an immediate deduction. And if you make payments on a note payable or mortgage through the company, the principal reduction portion is not deductible. On the other hand, you also get to take depreciation and amortization which are expenses when it comes to taxable income. But, they don’t require any cash outlay.
Those are just a few of the reasons why your cash isn’t going to have anything to do with your taxable income. There is one financial statement that deciphers all of this. It’s the most under used and misunderstood statement, in my opinion – the Statement of Cash Flows.
If you can learn how to read this statement, you’ll never worry about where the money went again!