Small Business

Avoiding the Debt Trap: Bad Financial Habits That Can Derail a Small Business

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Starting a business requires a substantial investment from its stakeholders. But if you don’t see quick returns on your investment, debt can accumulate, crushing your plans of a successful venture.

According to a recent survey, 34% percent of small business owners report $5,000-$15,000 in personal debt related to business, while 28% report $15,000-$30,000 in debt. While some debt is unavoidable, there are notorious debt traps that can trap new entrepreneurs.

If you’re just getting started, beware of the following:

Failure to budget.  At Magone & Company, we recommend that most business owners have two to three different budgets — an internal planned budget, an overachievement budget and a budget that considers negative outcomes. Because even if your business is generating a profit, it’s easy to lose of track of where all your funds are going.

Sloppy bookkeeping. In the early stages of a new business, it’s critical to track all expenses, sales, operating costs and taxes. You need to know where your money is going and be prepared to make changes to operations if necessary.

Not separating personal and business accounts. Comingling accounts can mean big financial trouble. Why? Because you can’t get a true snapshot of the financial health of your business. Don’t mix business with personal — especially when it comes to your finances.

Credit card rewards. In theory, a business credit card may seem like a great idea for general business expenses — like supplies, office furniture, entertaining vendors or business trips — and earning points and rewards for every dollar spent. The catch is you have to spend a lot to earn a little. If you’re carrying a balance each month, you’re also accumulating interest, which means more debt owed. If you’re going to use a business credit card to take advantage of the rewards, be sure to pay your balance in full each month.

401(k) withdrawals. Tempted to borrow from your 401(k) until you generate more revenue? Remember, this hurts your retirement savings and long-term growth potential. And if you’re under age 59 ½, you’ll also have to pay taxes on the premature distribution.

Falling for high-cost loans. Business loans can come with interest rates as low as 3% — and as high as 150%. An ethical lender will only approve a loan that’s realistic to repay, but you can get lured into a bad deal. Be sure to read the loan contract, ask about origination fees and make sure you are clear on the annual rate before committing to the debt.

 Gain control over your bottom line

Take charge of your finances now — before it’s too late. The professionals at Magone & Company can help you navigate debt traps and implement smart debt management practices. Call us today at (973) 301-2300 for a specific evaluation of your situation.

A Chapter 11 Filing Doesn’t Always Mean the End

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In a roller-coaster economy, a struggling company might decide to seek a fresh start under Chapter 11 bankruptcy proceedings — especially if its leadership believes the business could eventually become profitable through debt relief.

Generally, filing Chapter 11 is done voluntarily by a company to protect itself from creditors. It differs from Chapter 7, which involves liquidating or selling off the assets of a business that’s closing its doors. Debts aren’t simply absolved by filing Chapter 11 — though they’re likely to be reduced or paid off over a period of years.

Instead, Chapter 11 allows the business to continue day-to-day operations, as it undergoes downsizing and liquidation. The goal of a Chapter 11 filing is to implement a more sustainable solution to pay off debts and reorganize the business so it may survive this process.

What to expect

There are five major steps involved in the Chapter 11 process:

Step 1. Once the appropriate forms are filed in court, the company is provided immediate relief — called an automatic stay — from creditors. A bankruptcy filing doesn’t always affect business operations, but it will likely influence the stock price of a public company and the borrowing costs for any business. The company continues to pay employees and provide benefits. It’s also able to keep dealing with suppliers and customers so that it may continue earning money.

Step 2. The bankruptcy court appoints a committee to ensure that creditors are dealt with fairly. Notice is provided to parties who believe they’re owed money by the company.

Step 3. The business proposes a reorganization or recapitalization plan. By law, the company has the exclusive right to propose a plan during the first 120 days of the Chapter 11 process. If the business proceeds in good faith, the period may be extended.

Step 4. Once the court collects all claims against a company, hearings are held to estimate the value of any disputed claims. And once the total value is determined, the business can establish whether its reorganization plan is viable. Sometimes, litigation over the priority or handling of creditors arises.

Step 5. A disclosure statement pertaining to all assets and liabilities is presented to the court. If the statement is approved by the court, creditors vote on a reorganization plan and the company distributes payments according to the plan.

Restoring your rep

Even though a business can overcome a Chapter 11 filing and thrive over time, its reputation with customers, suppliers and employees may take a hit. If your company is thinking about filing Chapter 11, be sure to clearly understand what’s involved and the potential impact on critical business relationships. Be sure to consult with your attorney and CPA to help ensure bankruptcy is the right move for a better future.

Don’t already have a trusted CPA working on behalf of your organization? Magone & Company has 30 years of experience assisting organizations during financial challenges. Let’s chat.

Boosting Your Working Capital: Small Steps for Big Gains

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The COVID-19 pandemic has had a drastic impact on the economy as the gross domestic product dropped nearly 33%. For small and medium-sized businesses, it created unprecedented cash flow challenges, as many struggled to maintain a steady stream of revenue.

But now, as the pandemic continues to ease, businesses should revisit their working capital plan to bolster their cash flow for the future.

Key drivers of healthy cash flow

By understanding all the ways you can increase your organization’s working capital and improve cash flow, you can best set your business up for long-term success. The following techniques can help:

  1. Carefully manage debt. Another side effect of the pandemic? High corporate debt. You can enhance your working capital by meeting your debt obligations in a timely manner, avoiding additional interest, fees and penalties. Find out if your organization qualifies for a more favorable interest rate to settle debt faster.
  2. Receive sufficient financing. Don’t let the fear of healthy debt keep you from making smart financing Short-term business loans can help supply enough liquidity to finance current operations without excessive risk. Take the time to determine your working capital needs, as well as your forecasted needs, before selecting any financing.
  3. Issue invoices on time. Limiting the time between your operating cycle (when you begin spending money on a project) and your capital cycle (when you finally collect money for a project) can help you earn a profit quicker and improve liquidity.
  4. Make sure you’re not overspending. Examine your budget, breaking down each component to see where you’re spending and what you’re spending. Are there areas of overspending or spending unnecessarily? Are business trips essential? By curbing the extras, you can improve your working capital.
  5. Take control of your inventory. Did you know that well-managed inventory is arguably the most powerful way to drive working capital increases? Avoid stockpiling product, improve turnover cycles and reduce slow-moving inventory.
  6. Grow your sales revenue. While this one may seem obvious, think about how you can generate more sales to earn higher profits. For example, examine your profit margin to determine if your prices are up to date. And explore new marketing channels to reach more customers.

 

The lifeblood of your business

Working capital is essential to your business — especially small and medium-sized businesses that often can’t raise funds as easily as large corporations. Reach out to the CPAs at Magone & Company to learn how we can help you maintain a healthy cash flow.

Financial Check-up: Is Your Organization Fiscally Fit?

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Comprehensive financial statements can help tell the story of your organization’s financial health. Together, a balance sheet, income statement and statement of cash flows can be powerful diagnostic tools to help evaluate its financial well-being. Moreover, by carefully analyzing them, you may be able to uncover potential money-management problems or even fraudulent activity.

Assets vs. liabilities — The balance sheet

A balance sheet provides a snapshot of a company’s financial health at a moment in time. One side shows the assets owned by a company, such as cash, accounts receivable and inventory. The other side contains liabilities or claims on the assets, including accrued expenses, accounts payable and equipment loans.

Current assets (such as receivables) mature within a year, while long-term assets (such as plant and equipment) have longer lives. Similarly, current liabilities (such as payables) come due within a year, while long-term liabilities are payment obligations that extend beyond the current year or operating cycle.

Net worth or owners’ equity is the extent to which assets exceed liabilities. Because the balance sheet must balance, assets must equal liabilities plus net worth. If the value of your company’s liabilities exceeds the value of its assets, net worth will be negative.

A focus on profits — The income statement

The income statement reports revenue, expenses and profits earned (or losses incurred) over a given period. A commonly used term when discussing income statements is “gross profit,” or the income earned after subtracting the cost of goods sold from revenue. Another important term — “net income” — describes income remaining after all expenses (including taxes) have been paid.

Sales, general and administrative expenses (SG&A) are also indicated on income statements, reflecting business functions, such as marketing, that support a company’s production of products or services. The ratio of SG&A costs to revenue tends to be relatively fixed — no matter how well your business is doing. If these costs constitute a rising percentage of revenue, business may be slowing down.

The income statement can reveal other potential problems. It may show a decline in gross profits, as expenses rise quicker than revenue. Common causes include hiring more employees than needed or doing an excessive proportion of low- or no-margin business. In today’s business environment, many companies are reporting lower gross margins due to rising labor and materials costs — unless they’ve managed to pass along these cost increases to customers through higher prices.

Cash is king — The statement of cash flows

The statement of cash flows shows all the cash coming in and out of a company. Your company may have cash inflows from selling products or services, borrowing money and selling stock. Outflows may result from paying expenses, investing in capital equipment and repaying debt. Ideally, a company will derive enough cash from operations to cover its expenses. If not, it may need to borrow money or sell stock to survive.

The statement of cash flows shows changes in balance sheet items from one accounting period to the next. It’s organized into cash flows from three primary sources:

  1. Operations
  2. Investing activities
  3. Financing activities

To complicate matters, non-cash investing and financing transactions are reported at the bottom of the statement of cash flows. These transactions don’t involve direct cash exchanges. For example, a machine that’s purchased directly with loan proceeds would be reported here.

Although this report may seem similar to an income statement, its focus is solely on cash. A product sale might appear on the income statement, even though the customer won’t pay for it for another month. But the money from the sale won’t appear as a cash inflow until it’s collected.

To remain in business, your company must continually generate cash to pay creditors, vendors and employees, watching your statement of cash flows closely.

 Ensuring tip-top financial shape

Financial statements can be valuable for many purposes — whether you’re evaluating the financial results of your own business or one that you’re considering acquiring, lending to or investing in. An experienced professional can help you assess your company’s financial health, including potential risks and areas of improvement.

Tax ID Theft Prevention: You Are Your Own Best Defense

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Any form of identity theft can be costly and unsettling. And it can take months — sometimes years — to fully recover. But tax-related identity theft can be particularly disturbing because it involves the IRS.

While the government agency has taken significant steps in recent years to help minimize the occurrence of tax-related identity theft, fraud continues to occur. Before you become a victim, learn how to spot it and stop it in its tracks.

4 red flags for possible identity theft

If you find yourself in any of these situations, proceed with caution.

  1. Your return is rejected. The most unambiguous indication of tax-related identity theft is when the IRS rejects your return based on a duplicate Social Security Number (SSN) or Employer ID Number (EIN).
  2. You’re asked to pay additional taxes. To trigger a refund payment, criminals often submit fictitious information to the IRS.
  3. IRS records are incorrect. Criminals often invent sources of income to appear legitimate to the IRS and facilitate a refund. If, for example, the IRS issues an EIN you didn’t request, a criminal may be using your business’s identity to submit fraudulent returns.

What now? Reporting fraud

If it appears your tax-related identity has been stolen, complete IRS Form 14039, Identity Theft Affidavit as soon as possible. The IRS will assign your case to an employee who specializes in identify-theft victims. They will determine the scope of the fraud, make any necessary corrections to IRS records and assign you a personal identification number to prevent criminals from using your SSN or EIN to file returns in the future.

You may also need to notify your state’s tax authority. Although less prevalent (because refunds are generally smaller), it’s possible someone could use your SSN or EIN to file a fake state tax return.

If you’re contacted by the IRS, it’s important to note that the agency typically reaches out via regular mail delivered by the U.S. Postal Service. Special circumstances may warrant a visit or a phone call, including:

  • A delinquent tax return/employment tax payment
  • An overdue tax bill
  • The need to tour a business as part of an audit or investigation

Prevention is the best defense

What can you do to reduce your risk of tax identity fraud? These simple tips can save you the headaches.

  • File early before a potential scammer has an opportunity to file a fraudulent return in your name
  • Ensure that your computer is well-protected from viruses, malware and other hacker weapons
  • Take advantage of the IRS IP PIN program. After you verify your identity through the Secure Access authentication process, the IRS will issue you a six-digit PIN to use for all communications with the IRS, including your tax filings

If you suspect you’ve become a victim of fraud or have questions about protecting your own or your business’ identity, reach out to the knowledgeable CPAs at Magone & Company. Our extensive fraud protection expertise can help keep your sensitive information under wraps. Give us a call today at (973) 301-2300.

Surprise! Improperly Forgiven PPP Loans are Taxable Income

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A new IRS memorandum has confirmed that improperly forgiven Paycheck Protection Program (PPP) loans should be considered taxable income, and recommends affected taxpayers file original (or amended) returns that accurately reflect the status of their loan.

You may recall that PPP loans were established to help small U.S. businesses impacted by the pandemic cover certain critical expenses.

Under the program, loans were forgiven if the borrower met three conditions:

  1. The loan recipient was eligible to receive the PPP loan. An eligible loan recipient is a small business concern, independent contractor, eligible self-employed individual, sole proprietor, business concern, or a certain type of tax-exempt entity; was in business on or before February 15, 2020; and had employees or independent contractors who were paid for their services, or was a self-employed individual, sole proprietor or independent contractor.
  2. The borrower used the loan proceeds to cover eligible expenses such as payroll costs, rent, interest on a business mortgage and utilities.
  3. The borrower applied for loan forgiveness and attested on the application that they were eligible for a PPP loan, they used the loan proceeds for eligible expenses, certain financial information was correct, and they met other legal qualifications.

When all three requirements were met, the loan (or a portion of it) was forgiven. But if they weren’t? The IRS memorandum confirms that any portion of the loan not meeting the requirements for forgiveness must be included in income and any additional income tax must be paid.

Consult with your accountant to determine if you need to file an amended return. Not working with a trusted advisor? Magone & Company can help — call us at (973) 301-2300.