Try This Simple Hack for Projecting Next Year’s Revenue

With a new year on the horizon, it’s time to lay the groundwork for next year’s operations. Although many business owners believe that budgeting is impossibly useless for small operations with widely fluctuating incomes, forecasting revenue reveals where you’re going in the coming year and helps estimate marketing targets.

Here’s a simple way to project next year’s revenue: On a spreadsheet, list in the first column your existing and prospective projects for January. A retail business with sales to the public will list normal minimum sales volume and extra customer volume. Consider allowing for possible higher weekend traffic by treating weekends separately.

In the next column, record the expected revenue for each line in the first column. Then add a percentage of probability for the projected revenue in the next column to the right. For example, you may have a 100% expectation of some work, but only a 50% chance of closing a new deal or attracting above-average traffic on weekends.

The last column to the right multiplies projected revenue by the probability percentages for each row. The sum of this column is your revenue forecast for January. Repeat the process for the subsequent eleven months, and add the twelve revenue forecasts together to determine expected revenue for next year.

This technique results in a meaningful scenario by turning hoped-for revenue into realistic results based on probability. So a 25% chance of making a million dollars realistically means you can expect a quarter million.

It’s easy, it’s useful, and you can start now.

How to Save Taxes as an S Corporation

Toward the end of each year, unincorporated businesses begin considering tax structure advantages to implement in the following year. One of these is obtaining S corporation status. When your annual profit reaches approximately $50,000, you may want to consider this option as a way to save on taxes.

If you do decide to convert your business into an S corporation next year, you’ll need to know that a great deal of planning is involved. The issue of converting to an S corporation is surrounded by multiple guidelines from the tax authorities, but no solid formula. Your accountant can help you navigate this labyrinth of guidelines and assist you in deciding whether the option is a good one for you and your business.

How it saves

Figuring out how converting to an S corporation can reduce a tax burden begins with understanding how proprietorship operations in the United States are taxed. Profit is subjected to two distinct taxes – regular income tax and self-employment tax. The latter is reported and paid on your annual income tax return, but it’s calculated separately from ordinary income tax.

Self-employment tax is a flat rate assessment on profit; it comprises contributions to the owner’s Social Security and Medicare accounts. Corporations – as distinct entities from their owners – do not pay self-employment tax.

How do you get paid?

Unfortunately, incorporated small businesses are confronted with the confusing problem of having to forward corporate profits to their owner(s). This is confusing because receiving a salary from a corporation you own doesn’t reduce your tax burden. Why? Because this salary incurs the Social Security and Medicare taxes you’re trying to avoid.

Compensation via dividends is even worse. Dividends do not represent an income tax deduction for a corporation. As a result, corporate income remitted to an owner as dividends is considered taxable income for both the corporation and the individual.

Special S corporation status eliminates this double taxation. Profit simply passes through to an owner for calculation on his or her individual income tax. No self-employment tax is assessed because the owner is receiving taxable profits as a shareholder.

Officer compensation

More complexities arise when the shareholder is the working operator of the enterprise in addition to owning the business. Tax rules do not allow this person to receive all of the compensation as a shareholder’s taxable profits. Enjoying the tax savings from operating an S corporation – in which you’re both the shareholder and officer – is only allowed when you receive reasonable compensation for your operational services. That means receiving some compensation as wages, which then incurs Social Security and Medicare taxes. But the remaining corporate profit after the cost of your compensation does escape these employment taxes.

Identifying compensation that satisfies the requirement for reasonableness presents a challenge to anyone serving in the dual role of S corporation shareholder and officer. But it’s not insurmountable. As mentioned previously, discuss this in your annual pretax meeting with your accountant, and he or she will ensure you’re in compliance.

Don’t Use Your Retained Earnings Account ‘Til Year-End

One item on your financial statements that can provide you with really useful information is called “retained earnings.” So it pays to understand it.

As one of the equity accounts on a balance sheet, retained earnings accounts show changes in assets. Most commonly, business profits trigger increasing cash or accounts receivable – both of which are assets. Profit growth raises retained earnings; on the other hand, business losses have the reverse effect.

Changes in retained earnings only occur at the close of an accounting cycle, which is typically at year-end. Throughout the year, the retained earnings account doesn’t change. Instead, the balance sheet has another equity account for current year profit or loss. Only when the year is complete does the balance in the current year account flow over into retained earnings.

Throughout the current year, retained earnings should continuously match last year’s final number. If you increase retained earnings to a figure that’s greater than the balance at the previous year-end, your tax accountant has no choice other than to adjust the current year’s profit; you’ll pay income tax on an additional amount that wasn’t really income. If retained earnings decline, the tax accountant must record the change as a non-deductible distribution or dividend rather than a deductible expense.

Never record a transaction that alters retained earnings. Distributions or capital contributions are changes in cash assets that are not a consequence of business earnings. If you want to record these events correctly, use different equity accounts – not your retained earnings account!

Start Planning Next Year’s Business Budget Now

Successful business owners start planning their annual budget early. In fact, now is the time to start. But relax: It can be a simple task. And when the planning process is wisely handled, the benefits of budgeting will far outweigh the cost of time spent preparing it.

Budgets should not be time-wasting exercises without staying power. To create a useful budget that will stand up through the following year, you shouldn’t be spending much time jotting down figures on a page; it’s clear thinking that will produce a strong financial model.

Budget according to business type

A budget should be as simple as the business type it embodies. A one-person operation, for instance, will probably have a basic budget that easily adjusts to rapidly changing conditions. A store or company with several employees generally requires a more refined budget. But take note: Detail is not the aim. Your objective is a useful plan.

A business budget is more than numbers on a spreadsheet. Instead, budgeting is a thought-provoking process. By creating a budget, you’re quantifying your expectations for the future. The process forces you to predict what’s likely to happen as a result of your intended actions. And with a budget, you also calculate the predicted impact of industry trends, demographic changes, and general economic conditions.

Build in flexibility

The simpler your budget, the easier it will be to compare with actual results. And you can always alter the budget for changing circumstances.

Budget planning begins with differentiating fixed and variable costs. Some business costs are fixed monthly amounts, but many other costs are dependent on the revenue you bring in.

When expected revenue changes as actual results unfold, it should be easy to revise the upcoming variable expenses as percentages of sales. Costs directly related to sales volume are either moved forward or scaled back, depending on the way the revenue is going.

With both fixed and variable expenses considered, your other concern is major nonrecurring expenditures. Your budget should give you confidence that spending plans are reasonable based on cash flow. If the budget shows available liquidity, you can plan for major expenditures. As the year unfolds with better- or worse-than-expected results, you can shift these expenditures to occur either sooner or later according to the level of importance you assigned to them.

Think before quantifying

Budgets ultimately save money because they compel you to prioritize. Adjustments to your budget assumptions depend on the thinking you did before you actually began quantifying anything. Although expenses are a certainty in business, cash is a limited resource. Budgeting identifies how much money to allocate for each category of expenditure and tells you when you can afford nonrecurring cash outlays for important but revenue-sensitive items, such as training, new equipment, staff additions, or a special marketing campaign.

Because budgeting entails as much thinking as calculating, it’s a wise move for all business operators to begin the mental portion of the process well before the year-end…like now!

Asset Trades Can Pose Accounting Challenges

What is an asset trade? Well, like trading in your older vehicle for a newer model, an asset trade occurs when a business owner wants to trade up to improved technology and a vendor offers trade-in value for the older equipment.

This can pose an accounting challenge. The main issue with asset exchanges is that they differ fundamentally from ordinary business income. Savvy business owners will want professional accounting advice to properly record these transactions in their companies’ books.

In a cash sale, the gain or loss is the difference between the book value and the money received. When you receive more cash than the book value, it’s a gain; when you receive less, it’s a loss.

In an asset exchange, the relinquished asset has a carrying value on the company’s books, typically its original cost less allowed depreciation calculated up to the exchange date. The gain or loss is the fair value of the received item minus the book value of the relinquished item.

This is the case only when it is a nonmonetary exchange for dissimilar assets, such as trading furniture for computer equipment. When assets are similar, as is the case for most trade-in events, no gain is recognized from the trade.

In these instances, the gain simply reduces the fair value of the received property. The new asset’s book value is equal to the relinquished item’s book value, plus additional cash spent. Gain is not realized until a future date when the received asset is disposed of for cash or dissimilar property.

Accounting for the Merger of Two Businesses

Frequently, two similar business enterprises merge into one as a way of making more money by reaching more customers at a lower cost. By creating one from two, total overhead costs are reduced and more efficient distribution channels are created. It’s called a merger.

Mergers come about in two ways: either through two owners combining their organizations or through one business acquiring the other. The latter happens frequently when a young operation grows by purchasing a mature business whose owner is retiring or moving. A tragic flaw in these promising arrangements is that the accounting for the merger is more often than not considered an afterthought.

Tangible assets and goodwill

Accountants refer to the bookkeeping system for assets as the “purchase method.” It’s best understood as allocating the purchase price to acquired assets, both tangible and intangible. Customer lists, business reputation, and seasoned staff are intangibles. This “goodwill” may have considerable value for the acquirer, but that comes at a cost.

The purchase price of an acquired business typically exceeds the fair market value of tangible assets, such as equipment, computers, and desks. This excess cost is recorded as goodwill, a special type of “other asset.”

Goodwill is almost always present in an acquisition because a purchased business is usually worth more than the sum of its tangible assets, which are recorded at only their fair market values. Goodwill is therefore a catchall category of everything else.

Purchase adjustments

Accounting for an acquisition becomes especially challenging when the target company is transferring accounts receivable, customer deposits, work in process, and liability for sales tax or payroll taxes. The amount paid when the purchase closes is adjusted for these items.

As an example, assume you are purchasing a business for $10,000. The equipment you’re buying is worth only $6,000, leaving $4,000 to the catchall category of goodwill. On the acquisition date, however, this business has accounts receivable of $500 and work in process (which will eventually become invoiced receivables) of $400. You have to pay for these items as additions to the $10,000 purchase price.

But the acquisition target has already conducted business that incurred $400 of payroll taxes and $100 of sales tax. You will remit those amounts in the future, along with such taxes incurred after the purchase.

So the seller must leave $500 of cash for you to pay these obligations created during operations from which the seller profited. In addition, you might assume $300 of debt that the seller owes on the equipment, and the seller also has to give you credit for those funds.

Amounts allocated to equipment and goodwill are still $6,000 and $4,000. But the purchaser has to pay $10,100.

The additional $100 arises from the circuitous route of credits. The purchase price is adjusted with $900 of credits to the seller ($500 + $400) but $800 of credits to the buyer ($400 + $100 + $300).

It’s clearly an accounting obstacle, but not an insurmountable one, providing you have professional accounting advice.

Know the Tax Rules for Business and Employee Gifts

Giving business gifts is a time-honored way of doing business, but there’s a right way and a wrong way to go about it. While many believe there is no limit on the amount claimed as a tax deduction for gifts to business associates, in fact, the U.S. tax code only allows a deduction of $25 per nonemployee recipient annually.

Tickets to events, such as concerts and ball games, are treated as entertainment expenses. Restaurant gift certificates are considered meal expenses; only half of entertainment and meal expenses are tax-deductible.

Employees

Special tax rules apply to employee gifts. Giving employees cash or equivalents, like gift cards, of any amount is considered taxable compensation. The gift amount is added to wages and is subject to payroll taxes.

Businesses can give nominal cost noncash gifts to employees, but the important word here is nominal. While the application is often vague, and it’s always wise to check, a gift such as a voucher for a free hotel stay typically is not subject to taxes.

Award programs

Employees also don’t incur taxable wages if a gift is received tax-free under a documented achievement awards program. An awards program must be open to all and cannot discriminate in favor of higher-compensated workers. The value of each award also cannot exceed a maximum of $400, and typically, the award is presented in a meaningful way through a company presentation.

Many of the tax rules are nebulous and therefore subject to broad interpretation. The important takeaway: if you don’t know, ask.

How to Record the Selling of a Business Asset

Selling a business property is an opportunity to develop an accounting system for properly recording these events and ensuring your small business is using the appropriate tax rules.

When you are selling business assets, the correct accounting procedure is to remove these transactions from ordinary income categories because they are nonrecurring items.

This process permits an improved perspective on routine sales, so you can happily compare past periods and assess trends without concern for any income distortions triggered by nonrecurring asset sales.

Selling an asset used in business is always reported on a different tax form than normal business income. Therefore, you (and your bookkeeper) need to ensure the sales price of each sold asset is recorded in a separate account for Other Income on the Profit and Loss Statement (P&L).

Some sales are complicated because they involve multiple assets. For instance, a sale of land with a building and a fence comprises three distinct assets. You must divide the total sales price among the assets sold.

Of course, the entire sales price is not profit. You also have the costs of the sale. These are recorded in an Other Expense account on the P&L. Examples of these expenses are commissions paid to a selling agent and delivery costs for sending the sold asset to the buyer.

Account for the gross sales price in your Other Income account. Then apply all the deducted selling expenses to your Other Expense account. Any amount withheld from the sales price that repays indebtedness you owed is applied to the Liability Account on your Balance Sheet for the loan. A loan payoff for more than the liability account balance is interest expense on the P&L. The net amount after all deductions goes to your cash account on the Balance Sheet.

Removing the asset

The biggest expense related to a business property sale is normally the original cost of the asset. This was not an expense deduction when you acquired it. Rather, it was added to an asset account on the Balance Sheet. A bookkeeping procedure that may be unfamiliar to you, but can be easily explained by your bookkeeper or your accountant, is the removal of a sold asset’s original cost from the Balance Sheet. It’s transferred to the Other Expense account.

It’s crucial to remember that some of the original asset cost has already been expensed as depreciation. Prior depreciation expense was offset by equal negative values to an asset account for accumulated depreciation.

This negative Balance Sheet figure combined with the account for the asset’s original cost shows net depreciated cost. The bookkeeping procedure that transfers the original asset cost to Other Expense must also move the accumulated depreciation for that particular sold asset to Other Expense. Consequently, the net depreciated cost becomes the primary component of Other Expense.

A complex collection of tax statutes applies different rules to different types of sold business property.

But this is a piece of cake for savvy entrepreneurs who know to account separately for each asset sale and its associated costs.

We’re Reexamining Our Processes: Any Thoughts?

Small businesses are the envy of larger companies: they’re nimble and able to adjust their marketing and customer offerings on a dime. However…when was the last time you audited your company’s processes, including bookkeeping, accounting, inventory, and production, and made them earn a place in your business?

The key is in asking tough questions. One in particular often elicits a response known as “the six deadly words.”

The question is: “Why do we do it this way?” And it likely produces the following answer: “We’ve always done it this way.” The six deadly words.

Chances are, few of your processes exist because they’re the best option for today. They were convenient, cheap, a temporary solution or one that worked well…10 years ago. So, reexamine them now.

Ask questions. Don’t accept the six deadly words as a response. If a process is outdated, ask your employees for suggestions to improve it. Ask your customers: they may see problems you didn’t even know existed.

Listen to the answers. Look for patterns. Are there tweaks that would improve your company’s operations, or are there deeper systemic problems?

While it might not be an option to overhaul your company’s systems now, looking for processes that are past their prime will help you plan a more efficient future for your company. And perhaps even get buy-in for changes from your employees and customers.

Don’t fear the six deadly words. Replace them with this positive eight-word statement: “We’re changing our processes, thanks to your input.”

Key Ratios for a Healthy Balance Sheet

It’s an outdated concept: entrepreneurs who believe that all they need to know about their companies’ finances is revenue and expenses are fooling themselves. Those who want insight into the true strength of their company are familiar with their balance sheet and the crucial financial evaluation it facilitates.

Getting started

The Balance Sheet is a tool for investigating the vital signs of your business. But before you start taking Balance Sheet health readings, you have to know what signals to evaluate; it’s essential to know the components of this financial report.

The three key areas on a Balance Sheet are assets, liabilities, and equity. Accounts in these sections show the balances as of the date of the Balance Sheet.

Assets are what the business owns, liabilities are what it owes, and equity is simply the difference between the two, the so-called net worth of the operation. When your business makes a profit or borrows funds, or you reinvest through a cash infusion, the money from these sources goes into some asset, such as cash. This balances against the increasing new worth or liability.

Further breakdown of assets and liabilities distinguishes their life span. Current assets are cash and things that can be quickly converted to cash, such as accounts receivable and inventory.

Items that are expected to stay on the Balance Sheet for more than a year are fixed assets, like machinery and computers. Similarly, current liabilities are payable in less than one year, while long-term liabilities come due in more than one year.

What’s important

Lots of current assets, such as cash, are generally considered an indicator of Balance Sheet strength. However, current assets, including growing inventory or accounts receivable, must be supported by higher sales. Businesses that require plenty of equipment find its depreciated value on the Balance Sheet. Accumulated depreciation is a negative asset that lowers the net value of fixed assets.

If your company is paid immediately by customers and has no need for inventory or equipment, the asset component of your Balance Sheet is nothing more than a bank account. At the same time, the operation is certain to have some liabilities.

A large amount of debt is typically a sign of trouble. A substantial amount of current liabilities ultimately will lead to serious problems. These are typically incurred by small businesses as credit card debt, sales tax owed, and payroll taxes payable.

A few simple key ratios can establish Balance Sheet strength. First is the current ratio, which is current assets divided by current liabilities. Aim for a result of 1.5 or higher.

Another fundamental gauge is the ratio of liabilities to equity. A strong Balance Sheet will have much less debt than equity, thus yielding a ratio well below 1.

Many other measurements are helpful, and some are particularly applicable to specific industries. Discussing the health of your Balance Sheet with your accountant will lead to ongoing examination of your business from a new, and ultimately very helpful, perspective.