Last year we wanted to get annual net income down so we could avoid some taxes. Did it with leases; might have overdone it. Now we’re wishing we had more cash and net income to work with this year. How do we find the right approach to tax planning vs. running the business?
THOUGHTS OF THE DAY: Don’t leave net income and tax planning to the end of the year. Put money away throughout the year, so that the year-end tax bill isn’t so intimidating. Look further out than one year. Make sure you understand the impact of principal payments on your future tax picture. Rely on the professional advice of accounting and tax experts you’ve come to trust.
Right amount of net income
Do a beginning-of-the-year forecast of how you expect things to go. Include your goal for net income, expected tax obligation, desired amount of money to go into cash on hand, the money needed for principal payments, plan for reducing your line of credit, and any other changes in debt.
Review your plan at mid-year and make adjustments if things have changed. At the start of the third quarter, have a formal sit-down with your accountant to review and make adjustments to your annual tax plan. Include a detailed forecast of what you expect to happen to revenue, profit, and balance sheet obligations during the fourth quarter.
Go over, in detail, your forecast for the year’s income, profits, and cash flow, to see if you’ve missed anything. Then memorize a monthly set of transactions to withhold funds for taxes, build up savings and reduce debt related to term loans and lines of credit. If the business is seasonal, schedule high and low amounts to match the seasonality of cash flow.
Take a realistic look at your ability to pay off the credit line and chip away at it rather than trying to make major payments in a few months. Keep your eye on the terms of the credit line — which may require you to get to $0 owed for 30 days at least once a year. Consider whether it might be smart to term out some of the credit line, so you can pay it off slowly over a couple of years, rather than trying to get to $0 within the immediate 12 months.
How does it affect your bottom line?
Take a balanced approach to building up cash as you pay down debt. Having cash on hand is as important, or more important, as paying off debts since cash gives you more options when deciding what to do.
Build-in discipline to set money aside every month, even in low cash months, and then keep it set aside. If you’re not sure you’ll be able to handle that, delegate the job to someone else who works with you on the finance side of the business.
Once you have a good handle on the current year, run forecasts in multiyear cycles, detailing the cost of upcoming leases and loan payments. Be conservative with your estimate of net income. If you are coming up short in profits, go back to the drawing board and figure out what you can do to grow more profitable revenue, or cut costs on less profitable products or services.
Ignoring the negative facts will only get you in trouble
You’ll need a plan to turn things around. Make a list of action steps you’ll have to take to fix any shortfall, including due dates and who will be responsible for taking action.
Many owners get into trouble with their forecasts because they forget that loans have to be paid off with after-tax dollars. That means that for every $1 in principal payments on equipment, lines of credit, mortgages, etc., you’ll have to earn $1.30 and set aside $0.30 for taxes at the end of the year. Make sure you build the extras into your plan.
Finally, keep in mind that the only way to build substantial value into the business is to pay taxes, which are an indicator that the business is profitable. Spend less time focusing on avoiding taxes and more time focusing on what it will take to make a substantial profit. Remember, at the end of the day, it’s not how much you avoided paying in taxes, it’s about how much your bank accounts and business valuation have grown.
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