Almost every small business owner will tell you that you’re not supposed to show a profit at the end of the year, at least that’s what they heard. That’s a really bad practice for several reasons:
1) It encourages small business owners to make irrational spending choices near the end of the year because “hey, otherwise I’d have to pay taxes on it”. I mean, do you really need an expensive national internet marketing campaign for your construction company located in Hewitt, NJ? Of course not, but we make those type of careless decisions at the end of the year because we are desperate to not show a profit.
2) It exhausts your cash and leaves your company short to start your next year. If you are like most small businesses, all of your profit (if you’re lucky enough to have one) is in your checking account at year end. By using it all to “not show a profit”, you’ve wiped out your ability to have cash to make purchases (either planned or unplanned) at the beginning of the year. You are purposefully putting yourself behind the cash eight-ball.
3) It reduces your chances of getting credit to grow your company. By never showing a profit, you have nothing to show a creditor in terms of your ability to generate income. It appears as if your company is barely surviving and thus not worthy of credit that you might need to fund expansion or major equipment purchases.
4) It means that you’ve given your company an interest-free loan. Many small business owners take a year-end “bonus check” to eliminate the profit. This works if you are a sub-S corporation, but it is essentially the same thing as letting your company borrow your salary throughout the year while you pay for things in your personal life on credit.
5) Lastly, it reduces the value of your company when it comes time to sell. If you work for 20 to 30 years to grow your company, add employees, increase your service area, build a reputation, but always show a loss or, at best, a small profit, you significantly reduce the value of your company when it comes time to offer it for sale when you’re ready to retire. Who wants to buy a company that has not shown a profitable year since its inception? The most that you will get out of it will be the value of the hard assets and maybe a little goodwill, instead of the multiple of the average annual profits.
So what is the right way to approach year-end? That starts on January 1st with a cash management system that calculates your profit, your pay and your taxes and puts them all aside as you go through your year. A good system would have cash ready for you to get paid what you’re worth on a regular basis, take profits out of the company on a quarterly (not annual) basis and have money set aside to pay the taxes for all of that – regardless whether you are a Sole-Proprietor LLC or a registered Subchapter S Corporation. Does such a proven system exist? Yes, it’s called Profit First. For more information on how it can help you, contact us today.
Despite what Peggy Sue said in her Algebra class in the 1986 movie, “Peggy Sue Got Married”, we do use what we learned in high school all the time. One of those things is the Commutative Property which tells us that a+b+c = a+c+b.
What does that mean to you? Well look at this equation which all small business owners live by. Income – Expenses = Profit
The Commutative Property tells us that we can also express that equation in a slightly different way that has HUGE implications for the average small business owner. Income – Profit = Expenses
Although it may not seem like a big deal, if you really look at it, this can change the whole way that you run your business. The first equation has you taking out your expenses and then using whatever is leftover to pay yourself some profit while the second equation has you taking out a portion of your income as your profit and then using what is left over to pay your expenses. The advantage to using the second equation is that you are guaranteed to take money home as profit instead of waiting until everyone else gets their take before you do.
Using the second formula encourages you to reevaluate how you are spending the money that is not directly tied to sales (Operating Expenses) like administrative salaries, rent, utilities, office supplies, etc. Studies have shown that when forced to, most companies can easily reduce these expenses by 10% without even noticing. The problem with most small businesses is, by using the first formula, they are never really forced to examine those expenses, never really forced to reduce them by 10% and thus, never really forced to produce a profit for their owners……YOU.
For more information on how Profit First can help you make money on each transaction, contact us today.
Our firm is one of the select few, nationwide, that have received a certification in Profit First. What does this mean for you? We will guide you with the methods to greatly increase the profitability of your business. Of course, we will manage your accounting, do your tax returns and help you with your books – but any accountant | bookkeeper can do that. We also provide the most important financial factor – maximizing your profits.
We are beginning our journey towards helping small business owners end their constant struggle with the fact that they work a million hours and never seem to have anything to show for it. All the vendors get paid, the tax man (hopefully) gets paid and the employees get paid. The only one missing in that list is YOU. If you’re tired of be that gerbil on the wheel and never reaping the rewards of your labor, check out this video.
Soon, IntelliGenz Business Solutions will be available to be your Profit Guide on the journey to a new and more satisfying small business ownership. If you would like to know more, just click here to sign up to get more information on our Profit First roll-out.
Please know that we value your privacy and will not sell or share your contact information with any other entity and will only use it to contact you regarding our Profit First program. You may opt out at any time and all contacts will be by e-mail unless you specifically request a phone call.
The IRS has recently issued new interpretations of what how a worker qualifies as a 1099 employee. They have become concerned over the large number of employers that are shifting their tax payments on to their workers by claiming the workers are “independent contractors”. The fact of the matter is, most such workers are actually employees and should be paid as W-2 employees. It is the rare exception when a worker actually is an independent contractor.
Here are the three criteria that the IRS uses to determine who is an independent contractor:
- Behavioral control. If the employer determines when and where the employee has to work — they are an employee. If the employer determines what tools the employee has to use — they are an employee. If the employer determines who has to help the employee, where they have to purchase supplies or services or even what sequence the work must be performed in — they are an employee.
- Financial control. If the employer has financial control over the amount of income made by the employee — they are an employee. If the employer pays the employee a regular guaranteed wage for a period of time (by hour, week or month) — they are an employee. If the employer prohibits the employee from making their services available to others in the same market — they are an employee. If the employer controls the employee’s ability to make a profit or loss — they are an employee.
- Type of relationship. If the employer offers the employee benefits such as sick time, vacation time, insurance or a pension plan — they are an employee. If the employer expects the relationship will continue indefinitely rather than for a specific period or project — they are an employee. If the employer hires someone whose expertise is a key component of their regular work product (i.e. a law firm hiring an attorney, a construction firm hiring a carpenter, etc) — they are an employee.
It should be noted that the employee is considered an employee if ONE of these conditions is met. It is not necessary for the employer to meet all of the conditions for an employee to be considered a W-2 employee.
Given this information, it is clear that most persons that are currently considered “independent contractors” really aren’t. So what does that mean for the small business owner? It means that you should immediately contact your tax adviser or the IRS to determine if you are following the guidelines. It will also likely mean that you will have to start treating these persons as W-2 employees and withholding their taxes in an appropriate manner. Failure to do so will put you in the cross-hairs of the newly hired auditors who are working specifically to investigate the 1099 vs W-2 issue.
For further information, see IRS Publication 15-A: “Employer’s Supplemental Tax Guide”