Tax returns can be confusing, especially for business owners reporting income from multiple sources. But whether you are a business owner or individual, understanding the difference between “cash flow” and “income” is crucial to managing your finances successfully.
It’s easy to see why people confuse or mistake the two terms. They are both financial terms related to money coming in or going out. Some people even use the two terms interchangeably, which adds to the confusion.
However, these two terms are not the same. They have distinct implications, offer different sets of information, and are applied in different ways, both in the management of your finances as well as at tax time.
Failing to understand the difference between cash flow and taxable income can significantly impact your financial planning and decision-making.
So, in this blog post, we’ll delve into more detail that will help you confidently navigate the nuances of this distinction.
To put it simply: income is a measure of revenue, while cash flow is a measure of actual cash movement — income represents the amount of money earned from various sources (wages, interest, profits, etc.) over a specific period, while cash flow represents the inflow and outflow of cash during that same period.
For example, a business may generate significant revenue but still experience cash flow problems due to delayed payments, high operating costs, or other factors. On the other hand, a business may have modest revenue but manage its cash flow effectively, ensuring that it has the necessary funds to cover expenses and invest in growth opportunities.
Understanding cash flow is crucial for business owners, as it affects a company’s ability to pay its bills, invest in growth, and ultimately succeed. For example, a positive cash flow indicates that a business has more cash inflows than outflows, while a negative cash flow means the opposite. A negative cash flow may show that a business is spending more money than it’s earning, which could lead to financial difficulties.
Cash flow can be classified into three types:
On the other hand, taxable income is the portion of income subject to taxation by the government. It includes wages, salaries, tips, interest, dividends, and other income received throughout the year. However, some types of income, such as gifts, inheritances, and life insurance payouts, are generally not subject to taxation.
As reported on an individual income tax return, taxable income may not always reflect the actual cash the taxpayer receives, especially in cases involving ownership interests in pass-through entities like partnerships, S corporations, and limited liability companies.
These entities are generally not subject to taxes on income at the entity level, meaning that determining the actual gross cash flow of the taxpayer requires adjusting the tax return figures. (We have previously discussed pass-through entities and other business structures on this blog.)
To calculate your taxable income, subtract any deductions, like contributions to a retirement plan or interest paid on a mortgage, from your total income. The resulting amount is taxable according to your tax bracket (generally, the higher your taxable income, the higher your tax rate).
Cash flow is not taxed because it is not considered to be a form of income for tax purposes. The movement of money in and out of an individual’s accounts can be used to pay expenses or debts. However, it is generally a better indicator of the liquidity of a business or individual and not an increase in wealth or the accumulation of assets.
While cash flow is not taxed, it can impact taxable income. For example, a business with a positive cash flow can invest in assets or pay off debts, reducing taxable income.
Similarly, if an individual has a negative cash flow, they may be able to deduct certain expenses or losses, which can also reduce taxable income.
Both cash flow statements and income statements serve different purposes and provide specific information closely connected to the definitions of cash flow versus income explained above.
An income statement shows a company’s revenue and expenses over a specific period, typically one year. It provides a snapshot of the company’s profitability and helps investors and analysts determine the company’s ability to generate revenue and manage its expenses. The income statement measures a company’s operating performance, determines the cost of goods sold, and calculates net income.
In contrast, a cash flow statement provides a detailed analysis of a company’s cash inflows and outflows over a specified period. It shows how much cash is available to the company after accounting for expenses, taxes, and investments. The cash flow statement helps investors and analysts determine a company’s ability to generate cash and its liquidity, which is critical for ensuring it can pay its debts and invest in future growth.
The income and cash flow statements are essential for evaluating a company’s financial health. The income statement provides a measure of profitability, while the cash flow statement provides a measure of cash availability.
Both statements are needed to evaluate a company’s financial performance fully. However, some analysts argue that the cash flow statement is a better indicator of a company’s financial health, as it shows how much cash a company has and its ability to meet its financial obligations.
Whether you’re a business owner or an individual, understanding the difference between cash flow and taxable income is essential for effective financial management.
Although they offer different sets of information, they are closely linked — for example, a cash flow statement could not exist without an income statement. So navigating the nuances and distinctions can be daunting.
Fortunately, you don’t have to do it alone. A professional tax accountant (like us!) can provide the expertise and guidance to help you confidently understand cash flow versus income, plan for your financial future, and achieve greater peace of mind.
If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.
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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
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