Archive for November, 2006

Tax strategy is highly focused on maximizing deductions – see for example my last post to Financial Think — but it doesn’t make sense to spend money for the sole purpose of getting a tax deduction. Let’s say you’re in the 40% combined marginal tax bracket. You spend $10K and you save $4K in taxes. Sounds good, but you still end up with $6K less money overall. You’re better off if you don’t spend the money in the first place.

Ending up with more money (creating wealth) is a big reason you’re in business. Distinguish between productive tax deductions that help you create wealth and lifestyle ones that don’t. A labor-saving piece of machinery creates wealth by letting you deliver more product at a lower cost, leaving you with more money in the bank. A contribution to your retirement account grows your capital base through the compound effect of many years’ investment returns. These productive assets beget more assets, thereby creating wealth. On the other hand, writing off a business dinner that, frankly, isn’t, or staying in a five star vs. four star hotel…these give you short-term enjoyment but long-term less money.

Finally, since saving on taxes sometimes requires you to first spend money, balance income tax strategy with competing uses for your company’s free cash. Every year at this time you’ll be faced with a number of options, all clamoring for cash. To help you get the lay of the land, I refreshed last year’s post, Competing Needs for Business Cash at End of Year. Certain themes bear repeating every year because entrepreneurial finance demands an ability to make smart decisions during the annual financial cycle.

If you’re not tax planning, you’re probably leaving money on the table. The three simple actions below will put you in the tax planning game, and then at the end of this post you’ll find a handful of links to short tax planning articles.

1. Just do it! Contact your financial advisor or CPA to get the ball rolling. Even if you don’t have a clue about what to do, a single meeting will quickly orient you, and then each passing year will sharpen your tax planning skills. Remember, tax planning pays for itself, and there are a finite number of strategies. It doesn’t take long to figure out and execute your strategy.
2. Include your business(es) and your entire family situation in the equation. By coordinating the treatment of taxable income and tax deductible expenses from every part of your life you’ll find more opportunities to save money.
3. Take a multi-year approach. In a blind rush to minimize this year’s income tax bill, entrepreneurs often end up paying more tax because they don’t properly balance deductions between this year and next year, when they might be in a higher marginal tax bracket, where deductions are worth more. Taking an even longer perspective, if you see an exit strategy in the near future, reconsider whether a C Corporation or S Corporation makes most sense – it can dramatically affect how much tax you’ll owe when you cash out.

Schadler Business Services in Martinez, California, offers some helpful tax planning ideas for both business and individuals — so of course you’ll read both! For general tax planning strategies from a layperson’s perspective, see Tax Never Sleeps and Tax Time Talk With Your CPA. Regarding the latter, we’ve said it over and over again through the years: entrepreneurs typically underutilize their CPAs. Be assertive and ask your CPA for tax planning help. And finally, for some more detailed tax strategy regarding owner’s compensation, check out Paycheck as a Financial Tool.

What’s different about this year might be the preponderance of retirement plan options for entrepreneurs. So if you haven’t set up a retirement plan, and before you commit to one for next year, it might be worth looking into the different options now available. It’s getting to be something of an alphabet soup out there, but it’s pretty easy to quickly narrow your options.

Clients and their bookkeepers/controllers often ask us for DIY business finance learning resources, yet no one we know wants to plow through a book cover to cover. Instead, they’re looking for more flexible learning opportunities that respond to immediate need. We write Financial Think to help meet that need. Another excellent resource among the many on the Internet is called Accounting Coach blog. Here’s why I like this site:

• Intermediate-level content hits the sweet spot for serious DIY small business financial managers
• Clear, succinct treatment of specific topics
• Clean visual design
• Relatively unobtrusive advertising
• Easy to subscribe to via RSS link.

For a good sample, check out a recent post that answers the question, “How Do You Reduce a Company’s Breakeven Point?”

Some of the topics don’t relate to most small businesses, which we define as between start-up and $10M in annual sales / 100 employees. And it doesn’t always put the tools in context of financial strategy – which tools to use, when, and how. But the site’s definitely worth an RSS feed or bookmark if you want to expand your resource pool and sharpen your financial management skills. In addition to the blog, it has online training courses and even crossword puzzles for a lighter way to learn.

Financial management solutions: from QuickBooks to CFO-level help. (800) 889-6484.

Effective January 1st, 2007, the IRS business mileage rate rises to 48.5 cents, up from 44.5 cents.

Whether four cents are a big deal or small potatoes depends on whether your company reimburses employees, including yourself, for lots of miles. But strategically it’s a big deal because this 9% annual increase is one of many that contribute to expense creep – the steady erosion of profit from lots of “little” cost increases.

Fight expense creep: exercise your options. For instance, the IRS mileage rate is the maximum tax deduction your firm can take for business miles, but you don’t have to reimburse employees at the maximum rate. You can choose 45 cents, 40 cents, 30 cents – you name it. Employees might grumble a little of course because it affects their compensation. And if the owner is driving those miles, she’s leaving money on the table: better to maximize this tax deduction opportunity.

Another option is not to use the mileage method at all. In fact, you can’t use the mileage method for auto expenses if your company owns and depreciates the vehicle. In this case you deduct the actual expenses – gas, maintenance, registration, insurance, etc. Which auto method best serves your business is a good topic for annual tax planning with your CPA.

Remember, when the IRS business mileage rate changes:

• Revise employee expense reports if your firm will reimburse miles at a higher rate
• Reimburse at lower rates any miles driven for medical, moving and charitable purposes.

For the IRS announcement, please click here:
http://www.irs.gov/newsroom/article/0,,id=163828,00.html

According to CNNMoney.com today, voters in six more U.S. states agreed to a minimum wage that exceeds the federal rate of $5.15 per hour. The six states: Arizona, Colorado, Missouri, Montana, Nevada, and Ohio. Separately in California, the state was already scheduled to increase its minimum wage to $7.50 per hour, up from $6.75 per hour, an 11.1% increase effective January 1st, 2007.

What does this mean for the small business CFO?

To start with, it’s a stark reminder of the “grow or die” maxim. In the face of rising labor costs, it’s difficult to survive, much less flourish, with a flat revenue curve. You must grow revenues to keep pace with rising labor costs. Even if none of your employees are paid the minimum wage, this still affects your business. Chances are that some of your vendors pay their employees at the minimum wage, and they’ll pass this increase on to you in the form of higher material or services costs. This is the impact of wage inflation on your business.

You grow revenues by raising prices P or selling more quantity Q. But sometimes that won’t be enough to solve the problem. You need to increase revenues generated per dollar of labor input i.e. labor productivity. Common ways to do this:

• Automation – labor-saving hardware, software, and equipment.
• Streamlining – eliminate unnecessary steps in your work flow.
• Quality control – reduce failures and the associated costs of re-work / warranty work.

On the other side of the question, you can hire less expensive labor:

• Automation (above) may let you deliver the same product with lower skilled and less expensive labor
• Move production to a state with less expensive labor
• Move production offshore.

Switching perspectives now to one of bookkeeping and human resources compliance, changes in the minimum wage mean you need to stay on top of labor laws that vary by state and sometimes by city or type and location of government contract. Your accounting department should monitor such changes.

The bottom line is that with respect to labor costs, you have to always be looking ahead. California, for example, has already scheduled another minimum wage increase for 2008. So before you finish next year’s budget, before you submit a bid on a multi-year contract, look ahead and be the guardian of your company’s future profits.

Minimum wage information on the internet:

California — History of California Minimum Wage
Federal — Federal Minimum wage
All states — Minimum Wage Laws in the States
San Francisco — San Francisco Minimum Wage