Small Business Taxes & ManagementTM--Copyright 2017, A/N Group, Inc.
There are some basic approaches to handling personal and business finances. And in most small businesses businesses personal and business finances are hard to separate. You're taking money from the business to eat and pay the rent; but the business needs money to survive and grow. The discussion below is on a basic level, but many individuals and business owners don't focus on them. And it's more than just borrowing at the lowest interest rate.
Cash flow projections. You can't make intelligent decisions if you don't make projections. Finding that you won't have enough cash to complete the new location is the worst time to go running to a lender. First, it appears you can't manage your business. Second, you're now at the mercy of the lender. Third, it may take longer than you thought to get the money. Fourth, your current financials will look worse than if you had applied earlier.
Buy or lease? There are pros and cons on each side, but there's no universal rule of thumb. There are a couple of points to consider. If you're looking at a foreign luxury car, leasing may be the way. It won't be too long before that car is going to start costing you real money if you own it. Dealer service and parts are at a premium and that motorized seat you loved so much could cost a bundle to fix. Leasing makes more sense. On the other hand, if you're looking at a car noted for reliability without too many features, you could easily get 150,000 miles without a major expense. Best approach here is to buy. The factors that affect the cost of a lease are the price of the vehicle, the anticipated resale value at the end of the term, and the current interest rates. But those are pretty much the same whether you lease or buy. The same can be true of equipment, especially items that become obsolete quickly. But equipment leases can carry a much higher imputed interest rate.
Cash or credit? Unless you've got so much extra cash you're taking cash to the bank in a wheelbarrow, taking a loan out on a vehicle makes sense. (It can also improve your personal credit rating.) Interest rates on used cars may be only 3% if you've got good credit. They're even less for new cars. Contrast that with a business loan at much higher rates where there may also be restrictions and personal guarantees. Take a loan and save the cash for your business or personal needs.
Match asset life and loan length. This is an old principle. Don't take out a 7-year loan on a car that may only last 5. You may have a balance due just when you need money for a down payment on a new car. And the interest rate will be higher (though still lower than other loans). And don't take out a 10-year loan on a new building. Chances are the loan will have a balloon payment and you'll have to refinance then. There are, of course, exceptions. If interest rates are much higher than normal, a loan that will be refinanced at a lower rate makes sense. But get good advice before breaking this rule.
Refinancing commercial mortgage. You may have a three-year penalty clause on refinancing in your home mortgage. There's a good chance there's no penalty at all. That's not true with a commercial mortgage. It's too complicated to explain, but refinancing a commercial mortgage early could be economically unfeasible, depending on interest rates and the terms in the mortgage.
Behind on taxes? Interest penalty/interest rates vary. Some are based on current interest rates. For example, the current rate on underpayments of estimated taxes is 4% for individuals; that's the same as what the IRS will pay you on overpayments. That's not a bad deal. Other late payments are set by law. If you're 1 to 5 days late on your employment tax deposits, it's a flat 2%; 6 to 15 days, 5%; 16 or more, 10%. The 2% doesn't sound bad, but you've only got the money for 5 days, tops. That's like 2% on a 5-day loan. That can add up to a draconian rate on an annual basis, depending on how often you have to make deposits. Can't pay your taxes on April 15th? File the return or an extension. The penalty for paying late is 0.5% per month; the penalty for not filing is 5% of the amount due per month. State rules can be similar. If you're having difficulty paying your employment tax deposits, you have to take a serious look at why. Talk to a professional.
Keeping money in the bank? Every one and every business needs a rainy day fund. But it doesn't make sense to hold a large bank balance just to feel secure and earning 1% (if that) while you're borrowing to finance your business at 12%.
Accounts payable and receivable. The best source of financing has generally been accounts payable. Most suppliers allow a certain time to pay before charging interest on late payments. It can be as little as 15 days or as much as 90 depending on the industry and other factors. If you're short of cash you should use the time to your advantage--but be careful about abusing it. A supplier may ignore occasional late payments, but start charging interest or putting you on COD if you're consistently late. The other side of the equation, accounts receivable, may be a necessary evil. You may have to allow customers time to pay. But don't let the customer abuse it.
Watch purchases. There's two sides to being rich--one is making more, the other is spending less. More than a few businesses have run into financial difficulty not because they didn't make enough, but because they spent too much. Opening a new location without adequate cash reserves, or expanding product lines. Hiring employees before they're really needed can be another major cause. Many small business owners feel compelled to invest in a building to house their business. That may be worthwhile for a warehouse, manufacturing or distribution center, but not as smart for a restaurant or service business. The surrounding area can change making the location a poor choice for a restaurant or service or retail business. And a building can eat a lot of cash, especially if you have to make major modifications initially or later. Best to wait until you're established.
Buying real estate? It doesn't matter if you're buying a home as your principal residence, a vacation home, a rental, or a building for your business, the smart move is generally to finance as much as you can. Real estate is generally easy to finance and, as long as you put a reasonable amount down, offers little risk. Interest rates are lower than many other types of loans. A home, rental, or building can usually be sold if you run into financial difficulty. That depends, of course, on a number of factors. Paying cash, if you have it, generally makes little sense. Save the cash for other uses.
Financing a business with home equity, credit cards. Using your home equity or credit cards to finance a business should generally be considered a last resort. While a home equity loan sounds cheap, you're risking your living accommodations and a potential cash source in an emergency. Credit cards are an expensive financing device. Your retirement funds fall into the same category as your home. But there are times to ignore the general rules. Hitting your retirement isn't as bad a move at age 30 than at 55. At 30 you have time to rebuild. Credit cards can be useful if you have an opportunity to make a purchase of equipment, supplies, etc. at an attractive price. But if you're tapping these funds it should give you pause for thought that you're walking a thin line. You shouldn't consider these sources for your start-up capital.
Consolidation loans, debt forgiveness. Consolidating credit card debt or paying it off with a home equity loan can make sense. But before doing so analyze why you need to do it. More than a few people have taken this approach only to see credit cards with no or a low balance and running them up again. This time with no real option. There's a difference between having a problem because of a one-time occurence such as a casualty loss and an recurring problem.
Breaking the rules. We've discussed the general rules. They can be broken, but think twice before doing so. Much depends on your individual situation. Fred is 55 and decides to cash in his retirement funds to buy a wood stove franchise in Southern Florida. But Fred's an only child and his parents, both in their late 80's are sitting on $10 million in real estate. While the franchise may not be a good idea, he doesn't have to worry about retirement. Or Fred wants to hang out his own shingle as a consultant. His wife has a secure, high paying job and their only child is in the fourth year of college. The best approach is to talk to a professional who understands all the rules. Your broker may not be a good choice. A CPA generally has a broad knowledge of business, finances, taxes, etc.
Copyright 2017 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 08/31/17