Cash Flow Q&A for Start-ups

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One of the most difficult balances to maintain in any business, but particularly small business, is the constant tug of war that happens between cash in and cash out. The nuances of how to keep enough cash on hand to pay expenses and cover the ebb and flow of sales seems more art than science. For small business start-ups who have little in the way of experience, and even less in savings and cash on hand, managing cash-flow can be confusing and challenging. Early business growth brings advice from all sides often leaving entrepreneurs scratching their heads and ultimately guessing at how to keep it all flowing.  Here’s a few of our most frequently asked questions with answers from our best small business advisors.

Q: What’s the best way to see how cash is flowing through my business?

A: Try using a cash flow chart. This visual tool can help you see the big picture of how money enters and leaves your business.  Start by making a list of all the start-up costs and one-time expenses, monthly fixed and variable expenses, and projected sales. The end results from the charting will help determine if the business is viable and how long you will need start-up funding.

 

Q: Are there tools I can use to better track cash flow?

A: The good news is that yes, there are all kinds of online, easy-to-use, and even some free applications that can be a great way to help you keep tabs on cash flow. The Small Business Administration website has a Start with the Cash Flow Template from SCORE.

Pulse is an online app dedicated to tracking cash flow.  With this easy-to-use app, you’ll be able to monitor cash flow, invoices, project future cash needs and even attach files to transactions to keep everything all neat and tidy.

If you’re already using Quickbooks, take a look at the Cash Flow Forecast Report that is imbedded in the software’s reporting features. It can provide you with a great deal of data on accounts receivable, accounts payable, bank accounts, and projected balances.

 

Additional key areas of cash flow include other key areas of your business such as the break-even point, inventory management, and handling overdue invoices. Let’s review the basics.

Know your break-even.

The break-even is the point where expenses out meet cash into your business – in essence, the point where your cash flow levels off. To find your break-even, create a spreadsheet that lists all income from sales on a daily, weekly, monthly and yearly basis.  Now put in all the of the expenses that must be paid out. After that deduction, you’ll find your breakeven point – when expenses and sales converge.

Breakeven Point = fixed costs / (unit selling price – variable costs)

 

Inventory management

The key to most wholesale and retail businesses is in the inventory. Too much inventory and you risk staling (if it is a food or expiration based product), or locking up cash flow. Too little inventory and customers can become turned off if they cannot purchase immediately.  If your lines of credit dry up, selling the inventory off is one way to increase cashflow, but if no one wants to buy the inventory you’re stuck holding it with little or no cash alternatives.

 

Overdue invoices

Small business wait time on accounts receivables are increasing.  According to a Wall Street Journal Survey, “64 percent of small business had unpaid invoices of more than 60 days old while 20 percent say the problem worsening.” Slow or no collections are one of the most difficult areas of small business to rein in. Try incentivizing clients to pay early or on time with a net 10 discount and a percentage charge for late payments.  If after implementing the above recommendations you still aren’t seeing cash flow improvement, it may be time to consider a collection service.  Collection agencies can take as much as 30 percent of the total amount due, so you’ll want to weigh your efforts to get the client to pay versus the cost of using collections.  Offer extended credit terms or credit card payments as an option.  If the client or company doesn’t have the funds to pay, the only other option is to take back the merchandise and return it to your inventory. Again, this may be a difficult process.

 

How can you speed up invoice payments? Invoice promptly after work is complete. Provide a detailed invoice including your work order, contract or other documentation, contact information, purchase order, Tax ID and account number.  Send the invoices electronically for even faster delivery. Reconsider your acceptable payment options such as Amazon Payments, PayPal, or other merchant services that can include credit cards.

 

Rule of Thumb

Business experts advise businesses to always try to have a cash reserve of 3-6 months to cover the slow months.  While this is the golden rule, like many rules, it often isn’t realistic when it comes to small business start-ups and managing limited cash flow. If you find that business is taking a dramatic turn and cash flow is severely restricted, don’t attempt to wait out the storm, says Van Ballantyne, EA owner of Counting House Associates in Greenland, NH.  “Knowing where your business stands at all times is the best small business advice we give,” continues Ballantyne.  “If a business owner can see that cash flow is shifting, she can make a strategic move to correct the issue or seek temporary funding before the deficit becomes too damaging to the company.”

If you would like to learn more about how to prepare your small business for its first tax filing or obtain guidance on future years, talk with a Small Business Advisor by clicking on the Find an Accountant link on this page.

To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice. Any information contained in this article does not fall under the guidelines of IRS Circular 230.

Why Do Businesses Fail?

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Recent surveys show that the survival rate of new businesses average about 20% over a five-year period. In other words, if you start 100 new businesses today, 20 of them will still be in business five years from today. The other 80 will have gone out of business sometime during that five-year period. These are generally well-known statistics. What isn’t as well known, however, is that of the 80% of new businesses that failed, over 60% were profitable when they went down!

How can that be? It sounds counter-intuitive that a profitable business would fail. However, it becomes easier to understand when you consider the impact of a small business accounting term called, “payment terms.” Payment terms are a measure of the number of days between the time a service is provided or a liability is incurred and the time payment is actually made. What are the average “effective” payment terms in a typical small business?

Cash in:

  • from Customers – “average” 45 to 60 days

Cash out:

  • Rent – in advance
  • Employees – 7 to 14 days (regulated by federal law)
  • Other Vendors and Suppliers – 15 to 30 days

In other words, there is a distinct timing gap between the terms on money coming into the business and money going out of the business. When you combine that with rapidly increasing sales, you find the most common reason that the rapidly growing, “profitable” businesses failed to survive — they just ran out of cash. They had to pay their landlord, employees, and suppliers BEFORE their customers paid them — and they didn’t have enough “Working Capital” in their company to bridge that gap!

However, they didn’t fail simply because they ran out of money. According to the research, that cash shortfall was just a symptom of the real problem. The real underlying problem was that they didn’t have the management information they needed to successfully manage a dynamic business. In other words, they failed to maintain bookkeeping and accounting systems to provide them with critical management information — such as how much they had in the bank, which customers owed them and when it was due, which suppliers they owed and when it was due, etc. — the type of information required on a day-to-day basis to successfully manage a business in a changing business environment!

An Example:

Think of it like this. Imagine what it would be like to go bowling if they put a curtain at the end of the alley in front of the pins and turned off the projector for the scoreboard. How successful would your bowling game be?

You would hear the pins clattering, and someone would tell you that you have another turn — at least until the game is over. And you might have a wonderful time exercising and socializing with your friends. But what do you think your final score would be? You wouldn’t know how many pins went down. You wouldn’t know whether your ball needed to go more to the right or to the left. And at any given point, unless you’ve been keeping track in your head, you probably wouldn’t know how much more time was left in the game. Nobody would want to go bowling in that situation. Yet this is, effectively, what happens when you run your business without good accounting information!

A small business accounting firm can help you get the information you need to run your business effectively!

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants, Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations. To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

Please be advised that, based on current IRS rules and standards, any advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty that the IRS may assess related to this matter. Any information contained in this article, whether viewed or subsequently printed, cannot be relied upon as qualified tax and accounting advice.  Any information contained in this article does not fall under the guidelines of IRS Circular 230.

Copyright Information 2011 Professional Association of Small Business Accountants

Help! I’m Being Audited

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After just a few short years in business for herself, it was her first run-in with the IRS and she was panicking.  Thankfully, she had used a certified public accountant (CPA) to help her set up the business and file her taxes each year.

Once she calmed down she placed a quick call to her accountant and faxed over a copy of the letter. She and her accountant supplied the additional documentation and answered a few clarification questions, the auditor’s concerns were answered and the matter was cleared. Susan was lucky and her situation was resolved quickly. Other business owners may be facing a more complicated process.

Who gets selected for an audit?
Generally, taxpayers are selected for an audit for a few reasons. Possible triggers could include a simple random draw of the taxpayer’s filing, several items on the return were questionable or exceeded acceptable thresholds, or the IRS has an interest in a particular business or industry and your business fit the profile. Whatever the reason, a taxpayer’s best defense is to seek immediate expert advice and quickly response to the audit notification.

Before Susan started her freelance graphic design business, she had a lucrative position as an advertising executive. After her second child she decided to leave her full-time position to start a home-based business. She had experienced a significant downward shift in her income from the previous year and had increased her deductions and itemizations to include equipment purchases, several business trips and client meals. All of these instances appearing separately wouldn’t raise a red flag, but together are more likely to trigger an audit.

The IRS is also increasing the number of random audits it performs in order to generate more revenue for the government’s operations. That being said, right now the IRS audits approximately 1.5 percent of all taxpayers each year. For taxpayers with income between $50,000 and $100,000 the odds are about one in one hundred to have a tax return examined. That number nearly doubles for business returns claiming over $100,000 in income. Rest assured that if you receive an audit notice that you are not alone.

There are four different types of audits typically requested by the IRS. These include the Correspondence Audit, Notice of an Office Audit, the Field Audit, and the Taxpayer Compliance Measurement Program audit (TCMP). Each audit type will require a different action on your part.

The correspondence audit is a letter from the IRS Service Center and will arrive by regular mail. The questions asked by the IRS can usually be answered by providing simple documentation in response. Most business audits do not occur in a correspondence audit and are reserved for small, simple tax returns.

The office audit notice will also arrive by mail. The letter will include details on specific items of your return that are in question. You can and should bring a tax representative with you to explain any documents you and answer questions posed by the IRS agent. A tax representative such as a certified public accountant, tax attorney or enrolled agent (EA) is the only legal representative you can bring into the process with you. The office audit is typically used for small, sole proprietors with annual sales under $500,000.

Taxpayers selected for a field audit will receive a personal phone call from the IRS agent who will want to select a date and time to visit the business. Representation at this meeting is highly recommended as the IRS often sees these site visits as an opportunity to review not only your tax year in question but also business operations. Your representative will be better able to advocate on your behalf and keep the auditor contained to your conference room rather than wandering about your business.

The last type of audit is the Taxpayer Compliance Measurement Program (TCMP) audit. The primary purpose for this type of audit is to help update the data used in the IRS scoring program. The audit will require a total review of the entire return including all forms of documentation. This is a highly time consuming and rigorous process,as the auditor will literally review the return line-by-line and all supporting documentation will be required. Your tax representative will be invaluable in the process.

Whatever the reason for the audit there are a few simple steps you can take to prepare your response.

1. Call your tax preparer or accountant and review the tax filing in question.

2. Call the IRS and request an extension of the time to respond to the audit. This
will allow you a little more time to gather your data and have a solid response
prepared. Generally extensions are granted for an additional 30 days for the first
request.

3. Collect all of your supporting documentation including:

a. W-2s

b. 1099’s

c. Meals, travel and entertainment receipts including mileage logs and calendar

d. Bank statements

e. Credit card summaries

f. Interest statements

g. Business expenses and any home improvement receipts

h. Bring only the documents and receipts that apply to the tax year in question.

An audit can be a terrifying process if you try to face it alone. With a skilled and trusted tax representative on your side, the whole event can go quicker and less painfully.

 

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants,  Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations. To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

 

Copyright Information 2011 Professional Association of Small Business Accountants

 

Should I Hire My Spouse In My Business?

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Your spouse may spend a considerable amount of time helping out at the office. Sooner or later, you will probably ask yourself the question, Are there any tax advantages to making my spouse a formal employee? While the answer depends on your individual circumstances and the structure of your business, there are a few important areas to consider before putting your spouse on the payroll.

Probably the major drawback to making your spouse an employee involves payroll taxes and workers’ compensation insurance. As with any employee, your business must pay employment taxes and workers’ comp on any wages paid to your spouse. And it must withhold Federal Insurance Contributions Act (FICA) and pay Federal Unemployment Tax Act (FUTA) taxes on all wages paid – including Social Security and Medicare taxes. For example, if your spouse is an employee in 2011, your company and your spouse must each pay a 1.45 percent Medicare tax on all of your spouses wages with 4.2 percent Social Security tax deducted from the employee’s paycheck on the first $106,800 of wages and the company being responsible for 6.2 percent. The silver lining to this scenario is that typically the payment of these taxes will be a deductible business expense.

If the combined income of both spouses exceeds the Social Security maximums ($106,800 for 2010), then you may want to have the income on only one family member, so you can reach the maximum sooner. It also can make sense to have the spouse receive even a small salary, even a few thousand per year, to maximize Social Security benefits, since benefits are normally based on the higher of the two incomes or equal to one half of the spouses income. Another benefit of being on the payroll is that the couple has access to the child and dependent tax credit, which requires that both spouses work to qualify.

If you’re a sole proprietor or you and your spouse are partners in a limited liability company, you may not need to pay FUTA and SUTA, but must withhold for FICA and Medicare. Corporations are not allowed these tax breaks, so consider your options carefully and see if what you pay your spouse in salary will outweigh the potential tax repercussions.

Income shifting:

Assuming your company is a C corporation, any compensation paid to your spouse would normally be left in the corporation. In other words, if your corporation is in a higher tax bracket than you and your spouse, you may save tax overall by paying your spouse a salary. Otherwise, there is no benefit (and possibly a detriment).

On the other hand, if you operate your business as an S corporation or a sole proprietorship, you do not have to worry about corporate taxes. The income from your business is reported on your personal return, whether or not your spouse is paid a salary. Result: In this case, there is no income tax advantage to putting your spouse on the payroll, although this should be reviewed carefully, since some states ldo not recognize the S corporation. Also note that the IRS is very specific about a reasonable salary. If they believe that you are paying your spouse an excessive salary for the position or title they hold, they will scrutinize both the salary and your tax statements.

If you operate your business as a C corporation, paying a salary to your spouse allows you to take earnings out of the corporation without paying a double tax. For example, if you take money out of a C corporation as a dividend, you’ll pay a tax on the original earnings by the C corporation and then another tax on the shareholder’s return when you receive the dividend. Money you take out of a C corporation for salary is taxed only once to the employee.

Retirement planning:

If your spouse was not working or earning a salary in the business previously, adding him or her to your payroll will increase the Social Security benefit upon retirement. Additionally, if your business has a qualified retirement plan in place, it may provide retirement benefits to your spouse as an employee.

For example, if you have a 401(k) plan, your spouse can contribute a portion of his or her salary to the plan on a tax-deferred basis. Or the business may make contributions on behalf of your spouse to a pension or profit-sharing plan. A plan like this can be very useful when a business owner wants to put more into his or her retirement plan, but is hitting the maximums with an existing retirement plan.

Another reason to add your spouse to the payroll is the ability to deduct business travel expenses. Under current law, you may deduct your spouses travel expenses only if he or she is a formal employee of the business. By putting your spouse on the payroll, you may be able to claim extra travel deductions if your spouse accompanies you on a business trip or makes separate business travel arrangements.

There are other factors that can affect whether or not you pay your spouse a salary. Be sure to look at the big picture with an accounting or business tax professional in order to see all your options.

 

PASBA member accountants bring the collective resources of a nationwide network of Certified Public Accountants, Public Accountants,  Enrolled Agents and other practitioners available to answer your tax and financial questions and streamline your business accounting, bookkeeping, and payroll operations. To find a trusted accountant in your area, visit www.SmallBizAccountants.com.

 

Copyright Information 2011 Professional Association of Small Business Accountants