Small businesses generally love it when customers pay in cash. Why? Because there are no transaction fees? Yes, but the reality is that it’s convenient and very profitable to forget to record all that cash coming in the door that you would otherwise owe taxes on.

Notwithstanding the ethical issues of intentionally under-reporting income, we believe reporting and paying taxes on cash income is better for most owners’ long term bottom lines. Besides, a smart tax strategy that optimizes deductions can help you avoid a lot of the incremental tax. We don’t want to discount the difficulty of implementing a shift in revenue collection and reporting practices. Once businesses begin handing money straight to the owners or workers, it quickly becomes accepted as a perk of the position and is hard to change. However, there are several factors business owners should think twice about when deciding how to manage and record for cash business:

Under-reported cash is a direct blow to the personal wealth of the owner.

The value of a small business is based on a multiple of the profits they generate. That means off-the-books transactions, while good for the recipient, are a massive blow to the personal wealth of the owner. As a basic rule-of-thumb, every unrecorded $1 is worth about $3 of business value. If you do a nice $100/day of unrecorded business, that amounts to >$100K of lost business value. This hurts the most when you sell, but when an external appraiser comes to value the business for assessing your personal or business borrowing capacity, they will evaluate your last three years of reported profits, (assuming you’ve kept things straight with the IRS). If you didn’t report every dollar, the company valuation will be low.

Businesses that operate in cash, especially under-reported cash, are harder to sell.

When it is time to sell the business, cash scares away buyers. As business buyers ourselves, we take a careful eye toward cash transactions, especially when they don’t show up on the tax returns. Verifying off-the-book transactions can be an impossible burden in due diligence, and the mere practice invites tension and distrust. In the worst situations, when cash is a significant share of the business volume, it can simply be a deal breaker.

Unrecorded cash tends to get spent frivolously.

Make no mistake, not recording transactions is less work. But, there’s a reason successful business owners plan and budget meticulously. They know their revenues and their costs. Human nature is to waste things that are free, and when you create “free” money in your business, which is how unrecorded money is often treated, it tends to get wasted on things of questionable value.     

Converting to card transactions has gotten way easier.

Companies like Square, Stripe, Paypal, Braintree and others have made moving from cash to card easier and cheaper than ever before. Options for business owners are now abundant, and many consumers prefer cards, even for small dollar transactions.

Cash disappears.Calculator and Balance Sheet

The obvious fact that most business owners understand is the leakage phenomenon. Because cash is physical, valuable, and untraceable, you have to expect a certain amount of leakage on cash handled by anyone that is not you. You are naive if you think that you see every penny. You don’t. And you never will.

Not reporting cash is illegal.

Just because everyone does it doesn’t make it right. I’ll leave it at that.