Managing cash from your business insurance claim: Everything you need to know

It’s a relief when your business finally receives that insurance claims payout. But what comes next once that check is in hand? Knowing how to use the cash effectively and understanding its implications on your finances can ensure your business bounces back stronger than ever. You’ll want to be sure you’re accounting for the payout correctly, staying compliant with tax laws and making smart choices about where to direct the funds.

Here’s a deep dive into what to know about insurance claims payouts and how to manage them effectively.

How do business insurance claim payouts work?

Business insurance is designed to make you whole after a covered loss. For instance, if a fire damages $50,000 worth of inventory, your payout could be up to the $50,000 you lost. How much you receive depends on various factors. For example, in business property insurance, one of the most important items after coverage eligibility is whether you have a replacement cost value (RCV) or an actual cost value (ACV) policy.

RCV gives you the money to buy everything new, while ACV only gives you enough for your inventory’s market value at the time of loss. That’s because ACV policies account for depreciation.

Different types of claims can also lead to varied payout structures, such as:

• Lump-sum payments: Provide the full settlement amount up front, allowing businesses to address damages immediately.

• Installment plans: Spread payments over time, often aligning with repair or rebuilding schedules.

• Conditional reimbursements: Require proof of completed repairs or expenses before releasing funds.

Common business insurance claim types

Here are a few common types of business insurance claims where your business may receive a payout:

• Property damage claims: Provide money for damages to your business’s building, equipment or other physical assets caused by incidents such as fire or theft.

• Business interruption claims: Gives money to compensate for lost income and operational costs after a business disruption, such as a forced closure after a storm or power outage.

• Liability claims: Payouts cover damages to third parties, such as customers or vendors, after a lawsuit. It can include legal fees. You may get sued, for example, after a customer slips and falls in your store, or you accidentally hit a client’s fence while moving equipment.

• Cyber liability claims: These payouts help address costs related to data breaches, including regulatory fines, notification expenses and restoration efforts after a data breach, ransomware attack or phishing scam.

Understanding the insurance claims process

Before you get your payout, you’ll first need to file a business insurance claim. Whether your claim stems from property damage, business interruption or liability issues, the process for receiving a payout generally follows three steps.

1. Filing the claim

You have to move quickly after determining that it’s worth it to file a claim. “An insurance claim has to be filed with the insurance company immediately after a covered loss,” says Daniel Gebreselassie, an insurance broker at Alpha Management Insurance Agency and an experienced accountant. You’ll need to provide all necessary documentation, such as photos, receipts, repair estimates or historical and actual sales data.

“Furthermore, the business has to make necessary arrangements [to protect] from encountering any subsequent damage,” Gebreselassie says. “They also have to document the loss and respond to the insurance company’s follow-up questions in a timely manner.”

2. Claim assessment

In cases of physical damage, the insurer sends an insurance adjuster to evaluate how much the damage or repair is worth. In other types of claims, you’ll work with claims personnel to determine how much your claim is worth. If you disagree with an assessment, you often have other recourse, such as requesting an appraisal in property damage claims or filing a complaint with your state’s insurance department.

3. Settlement agreement

The insurer reviews all documentation and findings and determines how much it’ll pay for covered losses, as per your policy’s coverage and limits, minus any deductibles. If you and the insurance company agree, the insurer issues a check.

How to account for insurance proceeds in your bookkeeping

In property damage claims, you’ll account for the inventory loss by lowering the value of the inventory by how much was lost and creating an insurance claims receivable, says Gebreselassie. Once the insurance settles the claim, you’ll deposit the check and purchase the inventory to replace the loss when possible.

Here’s what Gebreselassie says your journal entries should look like if you lose $10,000 in inventory:

Initial entry:
Debit: Insurance claims receivable $10,000
Credit: Inventory $10,000

When you receive the money:
Debit: Cash $10,000
Credit: Insurance claims receivable $10,000

When you purchase the lost inventory:
Debit: Inventory $10,000
Credit: Cash $10,000

These are some general guidelines. Your journal entries may vary a bit if you have another type of claim. Regardless, when your business receives an insurance payout, keeping things simple and organized is essential. Here are some additional tips to make sure your financial records are accurate:

• Keep detailed recordpers: Write down everything — the claim, the amount you received and how you use the funds. This will make things much easier if you’re ever audited.

• Know where to record it: Depending on what the payout is for, you’ll either record it as “Other Income” or use it to offset related expenses. For example, damaged inventory could reduce your cost of goods sold.

• Track all recovery costs: If you spend money fixing the issue, such as hiring contractors or buying new equipment, keep receipts and categorize them correctly. Your expenses might be tax deductible.

• Match the payout to the loss: Ensure the insurance money matches your reported losses to avoid confusion or problems during an audit.

If you’re unsure how to record your claim payout, consult a tax professional or accountant to avoid errors and make the process smoother.

Taxes on insurance proceeds

“Funds received from an insurance settlement are usually tax-free because there is no gain involved,” Gebreselassie says. “You are simply getting back what you lost due to a covered risk,” not generating income.

However, there are exceptions to consider:

• Business interruption insurance: Payouts covering lost profits are typically taxable, as they replace income you would have earned.

• Exceeding your basis: If the payout exceeds the original cost or adjusted value of the damaged property, the excess may be taxable.

• Deductible expenses: If you deducted the damaged asset’s value as an expense in prior years, part of the payout may be taxable.

Tax laws can be confusing and complicated, so talking with experts about the potential tax implications of your payout can help avoid IRS surprises later. Some things you can do to prevent tax mistakes are:

• Consult with a tax professional: They can help you understand the tax treatment of your payout and ensure compliance.

• Review prior deductions: Check past tax filings to see if you deducted money for your loss in other years. This can influence how the payout is treated.

• Keep thorough records: Documentation is crucial for supporting your claims and deductions should you ever be audited.

6 ways to use cash from a business insurance claim

Now comes the time to decide how to use your policy’s payout.

“If [a business] chooses not to replace inventory or property after a loss, that is their prerogative,” Gebreselassie explains. Still, it’s wise to weigh the long-term impact of using the money for other purposes before spending it.

With that in mind, some options for what to do with the cash include:

• Restoring damaged property: Assign funds to repair or replace damaged assets, such as equipment, inventory or buildings.

• Reinvesting in operations: Use the cash to fill in any gaps caused by the loss, such as hiring temporary staff or restocking supplies.

• Improving resilience: Consider investing the money back into your business to prevent future losses, such as upgrading security systems or implementing disaster recovery plans.

• Upgrading infrastructure: Replace outdated equipment with more efficient models to help employees be more productive.

• Expanding operations: Use the funds to open new locations or expand your service offerings.

• Strengthening cash reserves: Bolster your emergency fund to better handle future disruptions.

While you have flexibility in using the funds, some restrictions may apply. For instance, if the payout includes funds reserved for specific purposes, such as liability settlements or third-party claims, you must use them accordingly. Failure to follow those conditions could result in legal or financial consequences.

Bottom line: Next steps

A business insurance payout is a key step in recovering from a loss. Understanding the claims process, accounting requirements and tax implications can help you make informed decisions about using the funds.

You might have other insurance claims to make in the future, so you should review all your policies now to guarantee you have as much protection as you need for those risks. As Gebreselassie advises, “The most important thing that businesses can do is update their insurance policies frequently when buying or renewing a policy.” For property insurance, he recommends your coverage be at least 80 percent of the actual costs of your assets.