www.HisCPA.com Taxes by the Book: A Biblical Guide to Tax & Business Management is now available on line at http://www.hiscpa.com/blog/ It will be published here in full and is a must read for all seeking to take God’s Principles to Tax & Business Management
First and foremost in keeping your company legitimate is to make sure that you keep your personal expenses separate from your business expenses. To keep and maintain a clear delineation of your company from your personal affairs you should only pay business expenses out of your business/corporate account. Accordingly you will want to ensure that you only issue monies for your personal affairs out of your business and not out of your corporate account/monies.
One of the first issues if a legal challenge is faced will be for the judicial authorities to determine if you have indeed acted and behaved as a corporation would and should under the auspices of federal and state law. Corporations and other legally recognized entities have many legal laws as well as formalized business practices that they should follow. Many times when a small business owner begins their own venture they tend to let the area between personal and business become unduly blurred when there is confusion between what is a personal item versus what is business. Tax law generally requires that valid business expenditures are those which are necessary for the valid business affairs of a business and for the furtherance of its survivability and profitability.
Often it is best to contemplate many of these questions in light of what you would do if a Fortune 1000 company employed you. If you were to ask yourself these questions in light of this environment then most of your decisions would gain clarity in this newfound light. If in working for a major company you were asked the questions below, what would be the anticipated/correct response:
- Would my corporation have an annual Board of Directors/Shareholders Meeting?
- If I were a corporate officer would I sign contracts in the corporate name while being sure to also list my title (i.e., President)?
- If I incurred business expenses, such as mileage, personally would I turn in an expense report to get reimbursed?
- Would I be expected to only pay valid business expenses out of the corporate account?
As you read through and evaluate these you can see that the answer to all of these particular questions is yes. As a benchmark to help keep you on track, please be sure to always ask yourself what would be the norm/expected if you were acting in a fiduciary relationship for another and what would be acceptable. In fact, though you may be the sole owner of your business you are indeed acting in a fiduciary capacity for your business as a corporation has most all of the same legal rights and responsibilities as an individual in protecting its rights and the full rights and abilities of ownership of all types of property both real estate as well as intellectual property. Given the ability to contract, a corporation may perform and expect others to fulfill their duties as detailed in a formal contract or everyday business practices.
Please be reminded that all business owners/entities are required to have a valid business license. Typically these are gained from the county in which you live, unless your office is within the city limits of a town/municipality. If so you will obtain your business license there. Also you will be expected to file annual tax returns, to pay a company’s annual registration with the state, file and pay payroll as well as sales tax filings and reports, and property tax payments and reports for corporate real estate and fixed assets. Thus, the services of a good CPA will bode you well as you strive to overcome the complexity of the varying tax laws and rules from the varying governmental agencies.
Using a computerized accounting package which has a balance sheet and profit and loss capability is a great start to being able to track your business transactions accurately and efficiently. Generally speaking for many small businesses QuickBooks is good system and often has much more capability than you will ever need. However this program is not a universal fit for everyone and you should take care to carefully evaluate your needs to ensure that you select a system which will work for you long term. Special consideration, for example, should be given if you need a POS/Point of Sale System, detailed inventory costing/tracking/and valuation, or if your business will require a multiple user system.
Being an expert at running your business does not make you one at the responsibility of accounting for your business. By applying our decades of experience we are well suited to guide you to track the financial and operational affairs of your business.
Financial Statement Preparation
All successful business owners either initially or over time become extremely proficient in their field of choice for it is by this growth of knowledge and wisdom which affords them the insight to make prudent decisions. Each and every hour of a business owner’s day, there are a series of insignificant and important thoughts and directions that directly impact the profitability of a business. Continually you are faced with making a positive impact towards bringing your business closer or further away from your goal. A company’s financial statement is the measuring stick by which you are able to gauge a company’s progress along the business continuum and are able to accurately measure the distance between where you are and where you want to be.
A well-presented balance sheet in good form will break out the assets and liabilities separating the long-term from the short-term items as well as a separate section for equity. Short-term items are those that are anticipated to be utilized/spent/collected/paid within the next twelve-month period. Long-term assets/liabilities are those whose ultimate disposition is to be addressed beyond the following year and not within it.
Balance sheets begin with the current asset section with cash usually listed first and then with accounts receivable and inventory following next. Any other short-term items would also be included in this section with care given to presentation to ensure that like kind items and accounts are appropriately detailed and segregated.
Subsequently the long-term assets of a business are listed, consisting of items that will be held by a business beyond the next twelve-month period. In this category you will find a company’s fixed assets such as equipment, furniture and fixtures, vehicles, and leasehold improvements along with their corresponding amortization. Other long-term assets might include any deposits the company has paid or other items anticipated to be an asset beyond the next year.
Next on a company’s financial you will find the current liabilities section, which will list all of the items a firm owes and believes it will need to address short term. This section typically will have included in it the accounts payable, payroll and sales taxes payable, customer deposits, and any short term portion of any notes payable (the long term principal portion of the note will appear on long term debt section which should immediately follow the current liability section).
The balance sheet ends with the equity/stock section which details a company’s stock, retained earnings/capital account, distributions/dividends, and the annual year to date net income (loss) of the business for which most accounting packages rolls forward from the profit and loss. Your distribution account should be closed at the end of each year to the retained earnings/capital account at the end of each year so that the net worth of a business might be tracked.
Profit & Loss
A well presented financial statement will be broken out in the sales section, cost of goods sold, and general and administrative expenses. Many businesses will break out their sales and cost of goods sold accounts into several categories that might be useful for review and analysis.
When reviewing your company’s financial, it is usually best to review your profit and loss being sure to show the current period under review as well as the year to date totals. This will have the added advantage of reviewing specifically the most current operations for any significant variances or trends as well as contemplation of where you stand vs. your annual and year to date goals. Your financials are best reviewed and presented when you also add a column which calculates items as a percentage of sales which allows the reviewer to have a good grasp/rule of thumb of which to measure operational results.
Often financial statements are unduly cluttered with accounts that have no financial, operational, or tax significance. A company’s statement should be concise giving the business owner as well as the CPA meaningful information without unnecessary data. A financial statement, like a heart monitor in a hospital, is the barometer that measures the lifeblood of a business, giving its holder critical and insightful information that is needed for all short and long term operational and strategic decisions.
Preparing and Reviewing Financial Statements is one of the most critical aspects to having information to properly manage your business. Our exhaustive experience in this field will help guide and direct you to understanding this critical aspect of your business.
Month End Control Procedures
The below procedures should be done at each and every month end so that you can better ensure that your internal financial statements accurately reflect your operating results. To gain a regular schedule it is best to “close the month” at a prescribed time such as 12:00 the last workday of each month and then to count all business done after the deadline as that of the next month. At each month end, for the below categories you will want to ensure that you:
- CASH. That at the end of each month that you ensure that all checks issued, deposits received, and any other cash transactions, (i.e., bank charges, automatic debits/payments, letters of credit, etc.) that have been recorded on both your QuickBooks/Accounting package and that they reconcile to the same balances. At the end of each month you will want to review it and all the data entered to do so to ensure its correctness and that your review your canceled checks to ensure all the checks recorded on the bank statement are enclosed and that all the canceled checks are valid expenditures of the business.
- INVENTORY. That you do a physical count of all that you have in the warehouse and accordingly adjust your balance sheet account up or down accordingly and that the offsetting part of the entry will be to cost of sales.
- ACCOUNTS RECEIVABLE. That you bill for all items shipped, close the month, and then run an open accounts receivable report and verifying that you have adjusted to this number on the balance sheet and reconciling why/if the balance sheet balance could be different from that of the detail as they should be the same. At this time please be sure to review the accounts receivable detail in detail verifying that the balances listed by customer are correct. You should start and maintain a file and keeping in it the entire month end open and unpaid accounts receivable reports.
- ACCOUNTS PAYABLE. That you record all items received, close the month, and then run an open accounts payable report and verifying that you adjust to this number on the balance sheet and reconcile why the balance sheet balance could be different from that of the detail as they should be the same. You will want to review the accounts payable detail in detail verifying that the balances listed by customer are correct. You will want to start a file and keeping in it the entire month end unpaid accounts payable reports.
Consistent month end control procedures are critical, as any variance to these will negatively impact the reliability of your internal financial.
Reading Your Business’s Financials
Whether your business is a billion dollars in revenue or a start-up venture in your basement, learning to read your business’s vital statistics is critical to your company’s profitability and even its very survival. Financial statements act as a warning bell helping the entrepreneur who reads them to become aware of trends, aberrations, calamities and successes. An owner who is well versed in reading and reviewing financials will always have a leg up on those who do not.
The words of the Bible teach us not to lean on our own understanding as by ourselves we are much more probable to wallow because of our limits and our own ineptness and though we are exhorted as Believers to seek wise counsel we are not to unnecessarily lean on others for all of our wisdom. “Plans fail for lack of counsel, but with many advisers they succeed”- (Proverbs 15:22). If our vision is too limited, we are unnecessarily handicapped and need a broader view in order to converse with the very professionals we all so desperately need.
Though a CPA, as a trusted advisor and friend, will dramatically strengthen your decision making ability, having equipped yourself with sufficient knowledge will prove invaluable as you plot your business steps. Being able to avoid miscues that befall your competitors will protect the gift of your business, which God gave you to provide for your family.
Cash is King
A solid business model will always require sufficient resources to meet the financial obligations of a business as they become due. To this balance, an owner will want to ensure there are substantive excess capital and lines of credit to meet varying and unexpected needs. Regardless of your accuracy as a planner and being able to anticipate the future events and needs of your business, there will always be circumstances and capital needs which arrive on the horizon that all of your contingency models have not anticipated. Thus, it is imperative that you maintain ample surpluses and reserves for such events.
Accounts receivable are the second most valuable of all of your business’s financial assets. Though you are not able to spend accounts receivables, they pale in liquidity only to your cash balances. There are many businesses such as retail that will not carry receivables, as their business is a cash and carry venture, which requires each and every purchase to pay for goods and services at the time they are received.
The best time for billing is at the time a service is rendered or a product is delivered. At that moment both you and your client are best informed as to what was agreed to and delivered. It is also this point of time an owner should be sure to verify that all items sold are billed for, the very best possible product was delivered and that due care was given to job costing considerations. Billing decisions will be paramount to your year-end profitability. After a bill is sent, there will never be another opportunity to influence the year-end results of your business.
Though each and every business and industry are specific as to the norm for billings and payments, it is wise to track two critical components in evaluating cash balances:
- Days in Receivable – This statistic calculates the number of days an item is in receivables relative to the sales volume. It is better to have your days in receivables lower than higher as this means there is less time between when a billing is sent and when it is collected.
- Aging Balance – A preparative of your aged accounts receivable will place your balances into columns based upon their age. This allows for a receiver to quickly review and access the status of all unpaid monies and to determine any specific collection steps that are warranted.
These calculations/reviews should be done at least monthly and more often as situations and sensitivity warrant. Tracking and comparison to prior periods will give an astute owner an early detection system to preclude and make corrections prior to unnecessary/unwarranted trends before they worsen and become problematic.
Due care and planning should always be exercised to ensure that all vendors, independent contractors and trade payables are paid on a timely basis. Individuals and companies who provide to and service your business should be able to always anticipate prompt and timely payment. Though most vendors will never have a security interest collateral or personal guarantee ensuring their payment, you should hold these monies in trust for them nevertheless. In fact, prudence would suggest that you never request or incur services if you do not have the cleared funds already in your account with them being specially earmarked accordingly. A business, which is not able to pay their just debts as they become due, is one whose business model is not working and their time potentially short lived.
Your profit and loss statement contains a recap of your business operating results and summarizes the positive and negative influences of every business decision you reach. Though many of the balance sheet indicators are somewhat lagging to predict a firm’s success, the profit and loss statement dramatically states and presents current financial data. There is no statistic, computation, component or percentage as important as a company’s gross margin. Beguiling a tale of success or failure the calculation of a business cost of goods sold and corresponding margin of profitability speaks volumes as to the firm’s management ability. Pricing of a ventures products and services are an integral component of ongoing operations.
A persistent review of pricing and a comparison to the corresponding costs to create these products or services will determine a firm’s niche in the market place, and its competitive advantage in the business climate in which it serves. A continual pattern and scrutiny of your gross margin will better enable you to maximize your operating results. Beyond a shadow of a doubt you cannot sell yourself out of a slump. On the contrary, if you persist in selling at below acceptable prices/standards, you will unnecessarily perpetuate an otherwise avoidable result. Gross margin analysis and their corresponding changes to operations dramatically heighten the probability of your business’s sustainability.
Discovering the pulse of your business is critical to hearing its needs and for its care and feeding. We work with clients everyday to both decipher and discern their business’s heart beat and to help you understand the nuances of what makes your business tick.
Profit & Loss Statement
To determine the future net worth of your business, a determined and insightful understanding of your Profit & Loss statement (P&L) is essential and critical. Though a balance sheet is a recap of what has happened to a business’s assets and liabilities to date, a P & L, if properly presented/managed/understood is a look into the company’s short as well as its long term viability. A businesses P & L essentially measures how well the business is utilizing company assets, personnel procedures and facilities in its effectiveness of serving customers while keeping a keen eye on profit maximization. By properly gathering and studying one’s operations and its corresponding P & L, one can learn much about a business which is useful for measuring rates of return, detecting both positive and negative trends, taking corrective action, and business valuation.
As with all ratios, care and attention should be given to evaluate them in light of company size, maturity, business climate and industry. Though there are many general rules of thumbs for a variety of different industries, there is no substitution for wise and judicious counsel of a wise and trusted business adviser/CPA. They will help evaluate these and many other nuances which make your particular circumstances, operating overhead and unique niche.
First in line of the analysis of your business P & L is to carefully evaluate its gross margin. This calculation is done by subtracting the company’s cost of goods sold from sales and by dividing its result by sales. Cost of goods sold is best measured as a percentage and proper care should be exercised to ensure that the periods P & L has properly allocated all direct sales cost to cost of goods sold. Typically most all of these costs will vary proportionally to the amount of product/services sold and delivered. A proper and consistently applied cut-off of accounting data is critical to this evaluation as otherwise the data/margins are unduly skewed to start.
What your business nets in dollars and as a percent of sales are an essential part of understanding your business. A business pre-tax margin is determined by subtracting from sales, all cost of goods sold, personnel, sales and operating expenses. Knowledge of this margin is essential as it is a leading indicator of business future assets; liabilities and equity as well as the respective income taxes it/its owners will owe/be required to pay.
Net Margin/Net Income After Taxes
A company’s net margin is what a business has made off of its base operations/business decisions reached during the year. It is what is earned after paying all of a business P & L charges, depreciation, interest and taxes to both the IRS and the respective states in which a business operates. To maintain a clear and adequate understanding of this in dollars, it is prudent to invest the needed time and resources to ensure that one has an adequate overview understanding of how their business is taxed. To that end, it is wise to be aware of several key components:
- Does the business keep its internal books on an accrual basis and file the tax returns on a cash basis? Are the appending timing differences carefully delineated, documented and understood? For example, business owners might inadvertently neglect to recall that receivables billed and reported in an earlier period when financials are prepared on an accrual basis will have to be reported on a subsequent years tax return when the cash based tax return is prepared.
- An understanding of the company’s effective tax rate, which is determined by dividing one’s federal and state income tax bill by the related sales for the period.
- A company’s marginal tax rate, which is the amount of tax that would be due as a percentage and dollars, on any additional profit. This is a critical component as the IRS tax system is graduated, thus requiring more tax, as a percentage to be paid on additional net income.
There are several hidden risks in acquiring debt that companies need to contemplate before acquiring debt/line of credit. Any of these issues either individually or collectively can cause irreparable damage to your firm’s ability to operate and continue forward. Often business owners who are flush with cash fail to make wise and judicious cash/debt decisions as they are inclined to believe the good times will last forever. Also before making any large non-recurring cash expenditure, care should be exercised to review the proposed transaction with projected cash needs as detailed in the company’s business plan.
Unfortunately, I have witnessed all too often companies spending all of the money they will soon critically need, simply for the lack of proper planning and advisement. An owner will also want to carefully contemplate a proposed line of credit/debt to be sensitive to its flexibility to meet an ever-changing business environment. Attention should be paid to ensuring the debt being requested is adequate as it is always better to have too much credit than too little. Also, the debt provisions should be carefully scrutinized to ensure that all provisions, repayment scenarios, and interest rate calculation and fluctuations are all well understood. Often banks and lending institutions will remove/negotiate several debt provisions in an effort to earn your business.