Limited cash flow can hamper the financial flexibility of midsized companies, but experts say a comprehensive review of business tax strategies can help protect the cash required to fund both short-term working capital needs and long-term strategic initiatives.
Taking a Closer Look at Tax Management
Examining your company’s tax strategy can be one of the most cost-effective ways to increase your company’s liquidity. However, experts warn that no single strategy works for every business, so it’s vital to align your company’s tax and business strategies to ensure the two are effectively integrated to meet organizational goals.
Strategic tax management is valuable for more than long-term operational and investment planning. It also can help you manage your company’s day-to-day revenue and expense streams. Following are some ideas that can help you learn more about the relationship between tax strategies and cash flow and about how best to implement these approaches without running afoul of tax laws.
From a tax perspective, the best scenario is to have as much revenue coming into your company as soon as possible, while deferring tax payments on that revenue for as long as possible. Several revenue tax strategies can help your company optimize its cash flow.
Experts say it’s a good idea to review your current accounting method to determine whether a change could help improve cash flow. Industries that carry inventory are required by the Internal Revenue Service (IRS) to use accrual-based accounting, where income is recorded when a transaction takes place—not when the funds are received, but other industries may have more flexibility.
In some circumstances, switching to the cash method, where you report an expense when it’s paid and record revenue when it’s received, can boost your company’s liquidity. The cash method holds the most tax advantages for companies with a large number of receivables, since tax payment can be deferred until the customer makes the payment.
Many accounting method changes require prior permission from the IRS. Before making any changes, talk to your tax advisor to determine when and how to file a change and when to make the switch. Companies that receive advance payments for goods, services, or a mix of the two aren’t good candidates for the cash method. They may be eligible to file for an automatic accounting method change to defer this revenue for tax purposes until the next fiscal year. This creates a permanent tax deferral to the extent the company continues to receive advance payments of an equal or greater amount in future years.
Virtually all taxes associated with revenue can affect a company’s cash flow—including sales and use taxes, franchise fees, standard income tax, and income tax incurred from states where your company has a business presence (a condition known as nexus). Analyzing each of these areas separately and as a whole can help identify opportunities to improve cash flow.
Managing Day-To-Day Expenses
While revenue-centered tax strategies can help boost your company’s cash flow, you also should consider tax approaches related to your day-to-day expenses. These include:
• Reviewing inventory accounting methods. Inventory accounting methods can have a profound effect on a company’s cash flow. For example, if you find your cost of goods is increasing due to inflation, changing to the last-in, first-out (LIFO) method of inventory accounting can enable you to accelerate the deduction of inventory costs when prices are rising. This approach may provide a permanent tax deferral because lowering ending inventory values increases the cost of goods sold, thus decreasing the company’s overall taxable income.
• Examining warranty reserves and other deductions. If you’re using a third party to process your warranties, you may be able to change your accounting method to take a tax deduction when the third party performs the warranty services rather than waiting for payment. Similarly, companies that self-insure their medical coverage can realize cash savings by changing their accounting method for incurred but not reported (IBNR) medical claims to take the deduction when the medical services are rendered to the employee instead of waiting until the claim is paid.
Whether your company is planning to grow, move, merge, or acquire, it’s important to adopt tax strategies that will advance your goals and help you with all stages of the business life cycle. Such events and their associated cash-flow strategies might include:
• New building construction or acquisition. If your company plans to build or buy a new building, you can take several tax initiatives to improve cash flow, including conducting a cost-segregation study to depreciate certain building items more quickly and identifying research and experimentation expenditures that qualify for a current tax deduction. State and local tax incentives also should be considered during this process. Tax credits, financing incentives, or other opportunities may be available to help fund this growth.
• New product line launches. If you plan to launch a new product that will require research and development, it’s a good idea to first conduct an R&D credit study to see if you qualify for a permanent R&D tax savings associated with the development of new or improved products, processes, formulas, software, or other technical business components. IBI