We’ve been struggling with cash flow all spring. We dug ourselves into a hole we didn’t need to be in. We bought a lot of equipment right at year end, because we had the cash to do it, and we wanted to reduce our taxes for last year. Unfortunately, we needed some of that cash to get us through the first 5 months of this year. Without that cash around, it’s been a lot of sleepless nights for me. Would appreciate your thoughts on what we might want to do differently, as we start to look towards tax planning for 2011.
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 they do 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 to get things on track. In this case, the owner spent 3 to 4 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 1/3 to 1/4 of the extra spending, towards taxes. The remaining 2/3 to 3/4 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 5 months of this year.
To achieve tax savings, the owner had to make the extra purchases by December 31, last year. Alternately, tax payments did not need to be completed until April 15, this year, since this company is an S-Corp and the owner pays taxes on the company’s reported profits. Focusing on paying taxes instead of saving taxes would have given the company 4 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 that 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 that 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? Keeping the Books: Basic Recordkeeping and Accounting for the Successful Small Business, by Linda Pinson.
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Andi Gray is president of Strategy Leaders Inc., www.StrategyLeaders.com, a business consulting firm that specializes in helping entrepreneurial firms grow. She can be reached by phone at 877-238-3535. Do you have a question for Andi? Please send it to her, via e-mail at AskAndi@StrategyLeaders.com or by mail to Andi Gray, Strategy Leaders Inc., 5 Crossways, Chappaqua, NY 10514.
