Cash inflow and outflow, simply explained

For many companies, tax season means stress. Not only do tax returns have to be filled out and sent in on time, but the IRS also needs an accurate overview of all of your company’s operating income and expenses in order to determine the amount of your tax payment. Small companies, self-employed in­di­vid­u­als, and free­lancers can all use cash-basis ac­count­ing for this. The prin­ci­ples of cash inflow and outflow are described below. But what exactly do those prin­ci­ples mean, and how specif­i­cal­ly are they applied?

Cash inflow and outflow play a decisive role in cash-basis ac­count­ing. To be able to submit your annual income to the IRS properly, you need to record all company revenues and ex­pen­di­tures, and offset them against one another. This just means citing what your company has taken in and spent during the fiscal year. So, for this form of profit cal­cu­la­tion, only the actual cash flow is taken into account. But what does that actually mean?

The revenues (inflow) and ex­pen­di­tures (outflow) are the sums that directly enter or exit the account. ‘Float’ amounts, i.e. money floating in the system between the two ends of a trans­ac­tion (before being deposited in the recipient’s account or being deducted from the sender’s account), are not counted here. Just look at the sums that have been entered or taken out of your account at which time. This approach is the basis of the cash inflow and outflow principle.

According to the IRS, cash flow in the method of cash-basis ac­count­ing must record income in the tax year when the payment was received, re­gard­less of when it was actually recorded in your books. An example of the cash inflow principle would be as follows: You’re a fiscal year tax payer and have adopted your fiscal calendar to start in July of each year. You receive a payment on June 30, 2017 but you don’t enter it into your books until July 1, 2017, the start of the new fiscal year. While it can remain in the new fiscal year in your books (fiscal year 2018), it must be processed for tax reasons in the gross income for fiscal year 2017 – the year in which the payment was actually received.

One point of interest is that the cash inflow doesn’t only decide the amount of your income, but also in­flu­ences your tax bracket and how much you pay – the higher your income, the higher your bracket.

The cash outflow principle also uses the timing as a deciding factor for your profit cal­cu­la­tion. Basically, it works just like cash inflow, but the timing of the actual payment is the decisive factor here. Expenses paid in advance are either counted toward the year in which they are applied, or subjected to the 12-month rule, which can po­ten­tial­ly split cash outflow across multiple tax years. Because payment date is so crucial for tracking cash outflow, it’s very important to keep all invoices and records of payment.

When it comes to cash outflow, there’s a special exception: de­pre­ci­a­tion, or the wear and tear of an asset (e.g. machines), may not be taxed for the full sum within one calendar year. The costs are instead dis­trib­uted over several years, according to the uniform cap­i­tal­iza­tion rules.

Income and expenses that are regularly recurring, such as rent, paychecks, insurance con­tri­bu­tions, etc. are ex­cep­tions and subject to special reg­u­la­tion. Depending on the date of the economic per­for­mance and the nature of the item, some things can be treated as if they happened in the current tax year, even if their economic per­for­mance hasn’t yet occurred. For example, shipping costs for sales can be matched to the tax year of the sale rather than the year of the actual shipment. The all-events test needs to be met. This is met when:

• All events have occurred that fix the fact of liability, and
• The liability can be de­ter­mined with rea­son­able accuracy.

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