Using Tax Logic to Manage the Value of your Business

In the real world of business management ownership you can only create income in 2 basic ways. These two income methods are taxed differently by good 'ol Uncle Sam.

The first method income is "earned" income. Let's say I'm a graphic artist and you hire me to create a logo. I design the logo and you pay me $250. That is earned income to me (assuming it goes to me and not into a corporation). The $250 goes into my gross income and I pay tax on it as high as 35% federal and depending on what state you live in, it could be over 45%. So your $250 of earned income (assumes no state tax) is worth only $162.50 in your pocket.

The second method is capital gains income. Capital Gains can be generated in many ways. Let's look at a simple example. You get on Ebay and find a great bike for $100, you buy it. Then a year later you're riding around the block on your $100 bike and a guy stops you and offers you $350 on the spot. You take it and walk home! You made $250 (same as if you designed a logo above) but this is capital gains and your tax on that is only 15% of your gain ($350 rec'd  - $100 paid = $250 gain). Your tax for this is $37.50 and your net in pocket is $212.50.

You get to keep $50 more if you earned your money through capital gains income.  This is just another reason why accumulating capital is important to long term wealth...if you have capital you can manage your taxes a lot better than if you only have earned income.

When running your business think of all the ways to build value that is taxed at 15% instead of 35%...over time it could be a lot more money in your pocket. Talk to your CPA to see if you have opportunities to maximize the availability of the capital gains tax rates.

Are you a business owner that wants to grow? Part 1

This is Part 1 of what will be several posts about growing your business. I'll cover some free ways to grow and I'll also talk about growth opportunities that aren't free.

I meet many business owners who want to grow but very few know how to grow.  Let's look some common ways to grow your business.

Low cost/no cost growth.

Train your people better so they get the most sales out of every customer encounter. 

        Example - How many times would you have ordered dessert in a restaurant if someone would just ask? At a restaurant that is missing opportunity, the server sees that I am finished with my dinner and the server walks up and asks "Would you like anything else?" My response, "No thanks."

At a different restaurant, the server sees I've completed my meal and asks "how would you like a slice of blueberry pie or a hot fudge sundae?"  I don't know about you but for me it's a lot easier to say no to the first server than the second one.

What's it mean to the business owner? If a dessert costs $5 and the restaurant serves 100 people per night, getting just 4 more people out of 100 people per night to order dessert means $7,300 per year in additional sales and the cost on that sale is the lowest you can have. All the help is already paid, rent doesn't go up, light bill is the same, etc. So the owner of that business could make $7,300 more per year because his servers just asked the same question a different way. That's as close to free money as a business owner can get.

Every business has these kinds of opportunities regardless of the industry. Take a close, a very close, look at your business and you will find opportunities to increase sales to your existing customers. Often the secret to good selling is knowing how to ask good questions. Are your people asking the good questions?

When is 95% less than 20%? When the 95% is wrong!

In my day to day activities I meet with 250 - 350 small business owners a year who are considering selling a business for one reason or another. In discussing their business the topic of customer service is brought up by me. The reason it is discussed is because significant value is added to a business with a loyal and happy customer base.

New 1099 Rules effect on Small Business

    This post provided by Paul Ikard, CPA

March 17, 2012  - Some of the below rules may have been modified, check with your CPA before taking any action.

Businesses and not-for-profit organizations are accustomed to IRS rules that require them to report certain payments on annual Form 1099 information returns. However, the recently enacted healthcare law imposes surprising new Form 1099 reporting requirements. Complying with them may add significantly to your organization's paperwork burden. While the new rules don't apply to payments made before 2012, it's not too early to start gearing up to deal with them.

Current Rules in a Nutshell


Background: For many years, businesses have been required to report various payments on different versions of Form 1099. For instance, when a business pays $600 or more during a calendar year to an independent contractor for services, the business must issue the contractor a Form 1099-MISC that reports the amount paid that year. The business must also furnish a copy of the Form 1099-MISC to the IRS. This reporting procedure helps contractors remember to include the payments on their tax returns, and it helps the IRS ensure that income is reported. Under rules now in effect, other types of payments that businesses must report on Forms 1099
include:
1. Commissions, fees, and other compensation paid to a single recipient when the total
amount paid in a calendar year is $600 or more.
2. Interest, rents, royalties, annuities, and income items paid to a single recipient when
the total amount paid in a calendar year is $600 or more.
When a Form 1099 is required, it must show:
The total amount for the calendar year;
The name and address of the payee;
The tax ID number (TIN) of the payee (For privacy reasons, it's okay to show a truncated
TIN on a 1099 issued to an individual);

Contact information for the payer; and

The payer's TIN.

If your business doesn't have a payee's TIN, you may be required to institute backup federal income tax withholding at a 28 percent rate on payments under Internal Revenue Code Section 3406. In most cases, the rules summarized above apply to payments made by not-for-profit organizations since they are generally considered to be businesses for Form 1099 reporting purposes. If a payer inadvertently fails to issue a proper Form 1099, the IRS can assess a $50 penalty. The penalty for each intentional failure can be $100 or more.

The Bush tax cuts debate and the real small business story

It's hard to avoid the politicians ranting either for or against the extension of the Bush tax cuts. Like many issues in life, for every complex problem there is a simple solution that is absolutely wrong.

Those opposed to the extension often try to separate the issue of "who" gets the extension. The theory is the high income earners should not get the extension and therefore pay more in taxes because they can afford it.

Those in favor of extensions for everyone say if the extension of the cuts isn't done it will cost jobs and be a drag on the economy.

In this case the unfortunate truth is they may both be right. So if they are both right how do we decide which policy is best.

Let's take the case of Mary who owns a pest control business. Like many small business owners her income can vary wildly from year-to-year. For the sake of this discussion let's say that she and her husband, who also works in the business, make $300,000 combined. Since many politicians have said that the tax cuts should not be extended for those who make over $250,000 let's use that as income above which the Bush tax cuts expire.

So let's go with that, Mary and Bob currently make $300,000 per year and, if the Bush tax cuts are eliminated, they are going to get a 10% tax increase on income over $250,000. I'll use round numbers again..their new tax rate goes to 40% from today's current 36%.

Now Mary and Bob have a good idea. They think they can grow their business next year and increase their income by $50,000 to $350,000 but they will need to hire someone for $32,000 a year to do the job. Seems like a good idea right? Spend $32,000 and make an extra $50,000..easy decision. Well, maybe not. Here's the math if the Bush tax cuts expire for her:

1. Mary pays an employee $32,000.
2. Mary makes additional $50,000 before tax and $30,000 after taxes (40% tax rate)
3. Mary pays additional tax of 3.6% (difference between old rate and new) on the $50,000 she already makes above the $250,000 tax increase line. That's another $1,800 in taxes

So what happened here? Mary made $50,000 more and has $3,600 less in cold hard cash. (The math is $50,000 - $32,000- $20,000 - $1,600 = -$3,600)

What would you do? Take the risk of hiring someone for $32,000 so you can lose $3,600?

The same situation if the tax rate for Mary is extended:

1. Mary hires and pays an employee $32,000
2. Mary makes additional $50,000 before tax and $32,000 after taxes (36% current tax rate)

In this case if her plan works Mary is break-even. Remember from above, if the tax increase goes into effect Mary will lose $3,600 if her plan works perfectly. Without increasing her taxes she's break-even.

What's the difference? If the tax increase goes into effect and Mary decides not to hire the new employee

 the tax effect to Mary is $1,600 and the new employee doesn't have a job.

If the tax increase doesn't go into effect what happens? Mary hires the new employee, Mary pays $18,000 MORE in taxes because she made $50,000 more taxed at old rate AND the IRS gets to tax the new employee on his $32,000 salary. Mary makes more money, another person has a job and IRS gets more money. But Mary had to be willing to take the risk! None of this happens unless Mary takes the risk. It's not the government taking the risk, it's Mary that has to take the risk. 

There are millions of people like Mary and Bob in the U.S. today making these same decisions every day.

The point of this is that nearly all financial decisions are made at the margin not based on the overall. Mary didn't make her decision based on the $300,000 she makes, she made the decision based on the next $50,000 she might make. 

Is the small business owner world upside down?

This post falls under the category of "what the heck is going on"!

The following is from a small business consultant who talks to small business owners several times a week and has done so for about 10 years. Their name is being with held for obvious reasons.

They say, many of the following are found to be true for abut 75% of small business owners:

• Business owners who sleep very well ....probably shouldn't.
• Business owners think because their employees don't complain the employees are happy
• Business owners whose employees complain blame it on the government
• Business owners personal spending is often unrelated to their personal income, some spend a lot more than they make and some spend a lot less.....very few are break-even
• Business owners who are chronically behind in paying suppliers are often right on time replacing their boat.
• For every one minute a business owner spends talking to an employee (shouting instructions doesn't count) they spend 54 minutes talking to sales people about a new copier.
• Whenever a customer says "your price is too high" the business owner believes it.
• Whenever a customer says "your price is too high" the business owner grumbles about how his competitors are losing money.
• A business owner would rather pay 5% more to a vendor than lose his invitation to the vendor's hunting trip.
• For every one minute a business owner spends getting expert advice they spend 92 hours giving it.

Ouch..................

Don't Let the Doom and Gloom in the Media Distract You!

If you are a small business owner the "psychology" of the day-to-day these days can be discouraging. Don't let the doom & gloom specialists get you down. Here are a few things to keep in mind that might help you get your mojo back:

• If your business is down don't be lulled into thinking that every business like yours is down. There is opportunity in more places that you might be currently considering.
• If the "economy" is down 10%, so what? If your biz has 1% share of market then you only need to get .2% of the other 99% to be back to even. If your small business is off you can do something about it.
• Down markets are GREAT times to expand. If your competitors are hiding in a bunker there is a lot of room to grow.
• Want to be more optimistic? Then stop watching the news or reading the newspaper. Instead study up on marketing....especially new ways to market. Believe it or not........ every business owner can be a better business owner but only if we let someone teach you something.

You can make your business better, more fun, more profitable and more valuable. Get to work.

Document My Systems?.....Which Systems?

Recently I wrote a post about how businesses should document their systems to improve their profits and value.

I received some feedback that went something like this..

"Which systems, there are a million systems in my business!"

Well, you're correct. Even a small business has many different systems. How you answer the phone, how to install the widget, how to log into your QuickBooks, it goes on and on.

So where should you start?

My advice is to make your first written/documented system the one that is most critical to the success of your business. That means you can rule out how to log on to your computer, how to check voice mail, how to refill the paper in the copier.

Here are some examples of critical systems for various businesses:

• If you have a staffing firm you need a great system for interviewing potential hires.

• If you  have an auto repair shop you need a great system for diagnosing car problems.

• If you own an ice cream store you need a system to make sure the ice cream temperature is always perfect.

What's the most critical system for your business? You'll need to decide, then write it down, diagram it, draw it... do whatever you need to do to make sure that someone can do it if you're on a sail boat in the middle of the ocean.

If it's in your head it's only useful to you, if it's documented it's valuable.

Why are sytems for your small business so valuable?

Documented business system are far more important than most small business owners believe. I believe that the reason too many small businesses stay small is because they don't have systems.

When I meet with small business owners and this topic comes up the conversation inevitably sounds like this:

Me, "Do you have your systems documented in writing?"
Business owner, "no, I'm here everyday so I can just tell the people what to do."
Me, "what if you weren't here everyday?"
Business owner....... blank stare....

Documented systems are the key to growth. If your business does not have documented systems you can not grow at any meaningful rate for very long and your costs will be needlessly higher. Documented systems cuts down on training and turnover of personnel, both of these lead to higher profits.

If you want to really improve your business and your day-to-day work life..... start today and write out one system.  Choose one that's easy and that you can immediately review with your employees (after you've written the system check with your employees so they can tell you how it is actually being done vs. how you think it's currently being done).

Writing out systems seems like hard work, and it is...but not nearly as hard as having to make every decision, every day for your entire business.

For some books that might help you get started click here.

Get those systems in place, I promise your business will be better for it.

Increase your small business profits without spending a dime......

I see and analyze hundreds of businesses every year. What I have found is small business owners (generally businesses with less than $3,000,000 in sales) have a consistent weakness that costs them dearly.

The Problem.......

A terrible lack of effort and intelligence in determining the correct pricing of their product or services. In my practice I often see the exact same type of businesses that are often only a mile or two from each other and their pricing is wildly inconsistent and illogical.

Here's a real life example:

I am changing names and details to protect the guilty.

Bill's Auto Service does $950,000 in sales and net profits to the owner, yep Bill, of about $75,000 (it varies quite a bit from year to year)..


Bill called me. He's considering selling his business and would like me to give him my opinion of his business value. Bill is getting ready to retire and is in pretty good shape but he needs to sell the biz for a certain amount to retire. I meet with Bill and go through the usual stuff. Bill has a nice clean biz with no real "deal breakers" that I can see. When I get to the part where I ask Bill about his pricing he gives me a common answer....
Me, "Bill, how do your set your pricing?"
Bill, "after all these years I have a feel for what my customers are willing to pay for certain kinds of repairs".
Me, "do your customers ever complain that your prices are too high?"
Bill, "all the time"
Me, "do they ever complain when your prices are too low?"
Bill, "Are you kidding?"
Me, "How would you know if your prices were too low, let's say on a timing belt change for a Honda?"
Bill, "I guess I'd be losing money, so I'd know."
Me, "how many timing belt's for Honda's do you do in a year?"
Bill, " I'd say 1 every other week..about 25 a year."
Me, "If you were $100 too cheap on that for a whole year would you notice not having that $2,500?"
Bill, "Probably not"
Me, "That's exactly my point."
Bill, "How do you think I should set my pricing?"
Me, "Let's do it right now. What would you charge for replacing a timing belt in a Honda Accord?"
Bill, " $550"
Me, "let's back up 15 minutes. Since I'm not a customer of yours and you said you know what your customers will pay...how did you decide on $550?"
Bill, "I get your point, what's next genius?"
Me, "let's get out the trusty phone book and start calling repair shops in your area and Honda dealers."

After about an hour we have 9 prices.. lowest to highest - $425, $475, $520, $550, $575, $590, $600, $675, $800. Remember Joe is $550. The $675 price is the Honda dealer.

Me, "Bill based on this info do you still feel that your price should be $550?"
Bill, "No way, I should be able to get what the Honda dealer gets, I can have the customer in and out in half the time and my warranty on our work is better!"
Me, "What about this strategy? Why don't you price the job at $650 and every time you quote the job you say to the customer..My price of $650 is less than the Honda dealer, I can have it finished in half the time and my warranty is better"
Bill, "that sounds good but what if they go to the other cheaper guys?"
Me, "Bill, those people are already cheaper than you, what difference does it make? Plus if you are making $100 more on each job you can do fewer jobs and make the same amount. You can afford to lose some jobs to the lower price guys."
Bill, "I guess you're going to tell me I should do this for all my work."
Me, "Either you do it or the smart guy who buys your biz will do it and guess what? He will get a bargain because the business is more profitable than you are letting it be. You will sell the biz based on profits lower than what the biz can generate if managed properly, no offense."
Bill, "Maybe I need to do some work if I want to get full value for selling the biz."
Me, "I agree, because I would rather sell your business for more money since I'll make more money!"

The point of this is as a small biz owner you owe it to yourself and your employees to get your pricing right! It's important and it's easy.

I am not kidding, the above is no exaggeration, too many small business owners simply pull out of thin air the prices for their products or services.  Are you that owner?








 

Top 5 things you can do in 2010 to increase the value of your small business

Big improvements often come from small changes. What could you do in 2010 to build the value of your small business?

1. Get professional small business accounting advice and follow it! Get your books set up in a way that makes your profit/loss statement a tool to run the business not just a piece of paper.
2. Stop trying to avoid taxes the risky (read...illegal way) and start taking advantage of small business tax breaks that are legal. First step, set up a small business retirement plan.
3. Decide to learn something new this year. You may have been doing the same thing for 20 years and you THINK it's right...but that doesn't make it right. No matter how good you think your business is... you are probably wrong. Do you have the nerve to find out?
4. Hire someone smarter than you this year. Do you have the courage for that?
5. Tell your employees thank you when they do a good job. Don't assume they only care about the pay check, they deserve recognition and you have to be the one to deliver it...sincerely. 

Nothing above is too difficult, unless you make it difficult. Now get going, it's a new year.

Good article on why you need to do more than cost cutting

As the saying goes......a small business can't save it's way into prosperity.

Here's an article on how to focus on the things that will help your small business succeed in good times and bad.

CLICK HERE

Hidden Costs of Doing Things You Shouldn't Be Doing

Outsourcing is a much discussed topic but I rarely see it focused on the primary strategic issues facing a small business owner. What I too often see is "Outsource and save money". This is rarely true. However, what I think the outsourcing industry should market is...."Outsourcing = spend more money and make even more money."

When I talk to business owners I ask them "what does your business do best?" I get all kinds of answers, some make absolutely no sense. I once had a guy who owns a auto repair shop say "I have a great website". My reaction... what??? I may look at things differently but I'd prefer that my auto repair shop was best at...well, I know you see this coming, I'd like my auto repair shop to be best at auto repair.

But in other instances I get business owners with the right answer but....

For example, I asked a staffing business owner what her company does best and she says "we're really good at matching the right person to the right job." That makes sense. So then I ask... "In what area does your business need the most improvement?" Her answer, "sales". Makes sense, so then I ask, "What area of your business do you spend most of your time in?" Her answer "bookkeeping and accounting". What???? I see this all the time, all the time. The business owner knows what they are good at and what they need to improve but they spend a very scarce resource, their time, doing things that don't contribute to the improvement of the business in any strategic sense.

Business owners who spend time on "non core" activities think they are saving money but they aren't. What they're doing is making themselves feel good by being busy.

The reason to outsource is not solely to save money because often times it's hard to see a dollar for dollar return on peoples time when outsourcing. But what outsourcing does is a) provide more professional, complete and reliable task accomplishment and b) frees up the scare resource of owner time so that the small business owner can concentrate on perfecting what the business does best and improving on the core areas that need improvement.

Want to have a better business that is more focused, more profitable and easier to operate? Try smart outsourcing.

Soon I'll add a post on how to begin the analysis of what you should outsource and what you should control directly.

List of Common Problems We See in Small Businesses

Below is a list compiled from talking to and evaluating hundreds of small businesses. Small business opportunities to improve are often very easy and inexpensive, it just takes a little attention to detail and a commitment to improvement. Here is my list:

1. Detailed written procedures for critical or repetitive tasks. Most small business owners struggle with "finding good employees" the problem is usually not that the employees are not "good" it's that new employees learn differently and written instructions can get new employees productive faster and less likely to get frustrated and give up.

2. No system to follow up on sales opportunities. It's incredible how often we see this. Customer calls, asks a few questions then says "I'll call back", business doesn't even ask for a phone number much less check back with the customer.

3. Poor accounting makes the financial statements essentially useless for operating the business. The lack of accurate financials makes budgeting very difficult and consequently we often ask the question "How's the business doing?" The answer, "Seems pretty good, I guess my accountant will tell me in March." Not good.

4. The small business owner really has no idea how his pricing is compared to competitors. They don't do any "research". Their only feedback is when their customers tell them "Your price is too high!" Duh, most customers will tell them that even if it's the lowest price they received!

5. Failure to seek expert advice until they have a problem. You know the saying, an ounce of prevention....... Often small business owners do not want to pay an attorney, CPA, financial planner because they think the issue won't be a problem....but when it is a problem... it costs them 10 times as much as it would have if they had done a little up front work.

Small business earnings definitions

When looking to purchase a business you will see all kinds of terms, many of which don't make any sense. Here's a list of common terms and a rough idea of what they mean:

Cash Flow - this is the worst definition used. It's an attempt to convey how much money is available to a business owner after all the expenses of the business are deducted from the revenue. Unfortunately Cash Flow technically also would include any increase or decrease in working capital items like inventory, accounts receivables, etc.

Seller's Discretionary Earnings (SDE) - This is calculated same as above but would include expense items added back that are not important to the business operations. Usually these add back items are owners "perks".... country clubs, entertainment, etc.

EBITDA - This is ..(E) earnings (B) before (I) interest (T) taxes (D) depreciation (A) amortization. The I&T will be different for the buyer than the seller so they are added back and a buyer will need to account for there I&T costs based on their debt structure. D&A are added back because they are non-cash expense. Meaning you don't write a check to pay for D&A like you do for payroll or utilities, therefore the deduction in the expenses is not real dollars but actually a tax deduction. Unfortunately (or fortunately) this does not adjust for a fair managers salary. Most business book the owners salary as "what's left" after all expenses and this number can swing wildly from year-to-year.

EBITDA+OC - This is the best definition but the least used. It's EBITDA as described above PLUS the owner's compensation. This is the real comparison number that should be analyzed when investigating the profitability of a business.