We”™ve been struggling with cash flow. We bought a lot of equipment at year-end because we had the cash and wanted to reduce our taxes. Unfortunately, we needed some of that cash to get us through the first five months of 2011. What now?
There”™s tax-reduction planning and then there”™s business planning. You have to do both. Unfortunately, most small-business owners spend way more time on tax reduction than on business planning. And as a result they live with a lot of challenges to how the business runs.
Think of tax savings as a short-term gain and a long-term loss. By forward spending money every year to save on taxes, the business chews up money that could have gone to profit and reserves. Then bills come due and the bank account runs dry.
Treating taxes like one more expense, just like lights, rent and office supplies, can help get things on track. In this case, the owner spent three to four times what the tax savings were, in order to qualify to save on tax payments for last year. In addition, some of the purchases were made on credit cards, which added interest costs.
Alternately, the owner could have put aside one-third to one-fourth of the extra spending toward taxes. The remaining two-thirds to three-fourths would still be sitting in the company”™s bank account. There would have been no credit card bills to pay off in 2011. And the company would not have been cash strapped in the first five months of this year.
To achieve tax savings, the owner had to make the extra purchases by Dec. 31, last year. Alternately, tax payments did not need to be completed until April 15, this year, since this company is an S corporation and the owner pays taxes on the company”™s reported profits. Focusing on paying taxes instead of saving taxes would have given the company four extra months of cash flow on the amount due for taxes, which it very much needed in the first quarter.
It”™s understandable why most business owners focus more on tax reduction. Tax payments are a forced event. Planning out where the business is going is left up to the business owner to find the time. In most businesses, no one is forcing the owner to work on business plans.
Business planning looks at where the business is going. Tax reduction looks at where the business has been. Focusing on the past without considering the future causes business owners to miss the picture of what they want to accomplish going forward.
There are tools to help with the planning process. Budget, forecast, cash-flow prediction and capital-expense planning ”“ for human capital, equipment and facilities ”“ are all useful. Accurately reporting on expense categories is also essential.
In order to keep the company safe and plan for a profitable exit, the company has to make money, save money and show a profit. The goal of tax reduction is to show that the business doesn”™t make money. That”™s the direct opposite of what most business owners want to achieve long term.
When it comes time to sell the business, the buyer wants evidence the business made money year after year. Proof of making money shows up on the company”™s income tax returns. Every buyer will want to see tax returns as proof behind the reports the company provides. If there are no profits on the tax returns, that makes it harder to justify a multiple of net income as a sales price.
Looking for a good book? Try “Keeping the Books: Basic Recordkeeping and Accounting for the Successful Small Business” by Linda Pinson.
Andi Gray is president of Strategy Leaders Inc., www.StrategyLeaders.com, a business consulting firm that specializes in helping entrepreneurial firms grow. Questions may be e-mailed to her at AskAndi@StrategyLeaders.com or mailed to Andi Gray, Strategy Leaders Inc., 5 Crossways, Chappaqua, NY 10514. Phone: 877-238-3535. Visit www.AskAndi.com for archived articles.
