This newsletter is intended to provide generalized information that is appropriate in certain situations. It is not intended or written to be used, and it cannot be used by the recipient, for the purpose of avoiding federal tax penalties that may be imposed on any taxpayer. The contents of this newsletter should not be acted upon without specific professional guidance. Please call us if you have questions.

Cash Flow - The Pulse of Your Business

There are frighteningly many small business owners out there who do not understand their cash flow statement. A shocking fact considering that all businesses essentially run on cash. And cash flow is the life-blood of your business.

Some business experts go so far as to say a healthy cash flow is even more important than your business’ ability to deliver its goods and services! You may find that perspective hard to swallow, but consider this – if you fail to satisfy a customer and lose that customer’s business, you can always work harder to please the next customer. But if you fail to have enough cash to pay your suppliers, creditors, or your employees, you’re out of business!

What Is Cash Flow?

Cash flow, simply defined, is the movement of money in and out of your business; these movements are called inflow and outflow respectively. Inflows for your business primarily come from the sale of goods or services to your customers. The inflow only occurs when you make a cash sale or collect on receivables, however. Remember, it is the cash that counts! Other examples of cash inflows are borrowed funds, income derived from sales of assets, and investment income from interest.

Outflows for your business are generally the result of paying expenses. Examples of cash outflows are... paying employee wages, purchasing inventory or raw materials, purchasing fixed assets, operating costs, paying back loans, and paying taxes.

Note: An accountant is the best person to help you learn how your cash flow statement works. Please contact us and we can prepare, if needed, and explain where the numbers come from in your cash flow statement.

Cash Flow Verses Profit

Profit and Cash flow are two entirely different concepts, each with entirely different results. The concept of profit is somewhat broad and only looks at income and expenses over a certain period of time, say a fiscal quarter. Profit is a useful figure for calculating your taxes and reporting to the IRS.

Cash flow, on the other hand, is a more dynamic tool focusing on the day-to-day operations of a business owner. It is concerned with the movement of money in and out of a business. But more importantly, it is concerned with the times at which the movement of the money takes place.

Theoretically even profitable companies can go bankrupt. It would take a lot of negligence and total disregard for cash flow, but it is possible. Consider how the difference between profit and cash flow relate to your business.

Example: If your retail business bought a $1,000 item and turned around to sell it for $2,000, then you have made a $1,000 profit. But what if the buyer of the item is slow to pay his or her bill, and six months pass before you collect on the account? Your retail business may still show a profit, but what about the bills it has to pay during that six-month period? You may not have the cash to pay the bills despite the profits you earned on the sale. Furthermore, this cash flow gap may cause you to miss other profit opportunities, damage your credit rating, and force you to take out loans and create debt. If this mistake is repeated enough times you may even go bankrupt!

Analyzing Your Cash Flow

The sooner you learn how to manage your cash flow, the better your chances for survival will be. Furthermore, you will be able to protect your company’s short-term reputation as well as position it for long-term success.

The first step towards taking control of, and properly managing your company’s cash flow is to analyze the components that affect the timing of your cash inflows and outflows. A thorough analysis of these components will reveal problem areas that lead to cash flow gaps in your business. Narrowing, or even closing, these gaps is the key to cash flow management.

Some of the more important components to examine are:

Some cash flow gaps are created intentionally. That is, a business will sometimes purposefully spend more cash to achieve some other financial results. For example, a business may purchase extra inventory to take advantage of quantity discounts, accelerate cash outflows to take advantage of significant trade discounts, or spend extra cash to expand its line of business.

For other businesses, cash flow gaps are unavoidable. Take, for example, a company that experiences seasonal fluctuations in its line of business. This business may normally have cash flow gaps during its slow season and then later fill the gaps with cash surpluses from the peak part of its season. Cash flow gaps are often filled by external financing sources. Revolving lines of credit, bank loans, and trade credit are just a few of the external financing options available that you may want to discuss with us.

Monitoring and managing your cash flow is an important task to perform in order to ensure the vitality of your business. The first signs of financial woe will appear in your cash flow statement, giving you time to recognize a forthcoming problem and plan a strategy to deal with it. Furthermore, with periodic cash flow analysis, you can head off those unpleasant financial glitches by recognizing which aspects of your business have the potential to cause cash flow gaps. With cash flow management and analysis, you will be able to plan on how you’re going to direct your cash surplus with assurance that you will have adequate funds to cover day-to-day expenses.

Planning Retirement Withdrawals

If you are thinking of retiring soon, or changing jobs, you may face a major financial decision: what to do about the funds in your retirement plan. This article will discuss partial withdrawals and full withdrawals.

Note: As you will see, the rules on retirement withdrawals are quite complex. They are offered here only for your general understanding. Please call us before taking withdrawals or making other major changes in your retirement plan.

Take a Partial Withdrawal

Partial withdrawals are withdrawals that aren’t the rollovers, annuities or lump sums. Because they are partial, the amount not withdrawn continues its tax shelter, see below.

A partial withdrawal will usually leave open the option for other types of withdrawal (annuity, lump sum, rollover) of the balance left in the plan.

Note: Before retirement, partial withdrawals are fairly common with profit-sharing plans, 401(k)s, and stock bonus plans. After retirement, they are fairly common in all types of plans (though least common with defined-benefit pension plans).

Tax Planning. A partial withdrawal is taxable (and can be subject to the penalty tax on withdrawals before age 59 ½ ) except to the extent it consists of after-tax contributions, such as nondeductible IRA contributions. The withdrawal is generally tax-free in the proportion the after-tax investment bears to the total retirement account.

Example: Your retirement account totals $100,000, which includes an after-tax investment of $10,000. You withdraw $5,000. The withdrawal is tax-free to the extent of $500 ($10,000 / $100,000 x $5,000).

Note: The tax-free portion is computed differently for plan participants who were in the plan on 5/5/86.

Preserving the Tax Shelter. Your funds grow sheltered from tax while they are in the retirement plan. So the longer your financial situation lets you prolong the distribution—or the smaller the amount you must withdraw—the more your assets grow. Some taxpayers choose to defer withdrawals for as long as the law allows to maximize assets and shelter them for the next generation.

The law has specific rules about how fast the money must be taken out of the plan after your death. These rules curtail the ability to prolong a tax shelter which was intended to aid your retirement.

Withdrawal Before You Reach Age 70½

Until the year you reach 70½, you need not take your money out of your retirement account—unless your employer’s plan requires this. In fact, there will usually be a 10% early-withdrawal penalty if you make withdrawals before age 59½. This is on top of the regular income tax you will owe at any age on amounts withdrawn, though there’s no tax on your recovery of after-tax contributions you made.

Once You Reach Age 70½

Once you hit 70½, withdrawals must begin. Technically they can be postponed until April 1 of the year following the year you reach 70½—say April 1, 2008 if you reach 70½ in 2007. But waiting until April 1 means you must withdraw for two years—2007 and 2008—in 2008. To avoid this income bunching and a possible higher marginal tax rate, your tax adviser may suggest withdrawing in the year you reach 70½.

The rules allow you to spread your withdrawals over a period substantially longer than your life expectancy. Under these rules the taxpayer (say, an IRA owner) first determines his or her retirement plan asset values as of the end of the preceding year. Then the owner takes the number for his or her age from an IRS table (the table is unisex). The number corresponds to the future period (at that age) over which the withdrawals may be spread. The owner divides that number into the retirement asset total. The result is the minimum amount to be withdrawn for the year.

Example: Joe reaches age 70 1/2 in October of this year. Retirement plan assets in his IRA totaled $600,000 at the end of last year. The IRS number for age 70 is 27.4. Joe must withdraw $21,898 ($600,000/27.4) this year.

Example: Two years from now Joe is 72 and his IRA was $602,000 at the end of the preceding year (when Joe reached age 71). The IRS number for age 72 is 25.6. Joe must withdraw $23,516 ($602,000/25.6) when he’s 72.

The distribution period in the IRS table in effect assumes distribution over a period based on your life expectancy plus that of a beneficiary 10 years younger than you. Only where your designated beneficiary is a spouse more than 10 years younger than you is his or her actual life expectancy used to figure the withdrawal period during your lifetime.

Caution: You can always take out money faster than required--and pay tax on these withdrawals. However, the tax code is strict about minimum withdrawals. If you fail to take out what's required, a tax penalty will take 50% of what should have been withdrawn but wasn’t.

Financial Calculator: Required Minimum Distribution
The IRS requires that you withdraw at least a minimum amount - known as a Required Minimum Distribution - from your retirement accounts annually, starting the year you turn age 70-1/2. Determining how much you are required to withdraw is an important issue in retirement planning.

Credit Reports: What You Should Know

How do lenders determine who is approved for a credit card, mortgage, or car loan? Why are some individuals flooded with credit card offers while others get turned down routinely? Because creditors keep their evaluation standards secret, it is difficult to know just how to improve your credit rating. It is important, however, to understand the factors and to review your credit report periodically for any irregularities, omissions or errors. Reviewing your credit report annually can help you protect your credit rating from fraud and ensure its accuracy.

Credit Evaluation Factors

There are so many factors that go into determining your credit. The list provided consists of some of the major factors considered:

These factors may be used, and weighted, in determining credit decisions. Credit reports contain much of this information.

Obtaining Your Credit Reports

Credit reports are records of consumers' bill-paying habits collected, stored and sold by credit bureaus.

Credit reports are also called credit records, credit files, and credit histories. Under Federal law, you are allowed access to free credit reports. There are three major credit bureaus and thousands of smaller ones where you can obtain a credit report.

These credit bureaus offer the free credit reports and monthly credit reports and services for a fee.

If you have been denied credit, you can request that the credit bureau involved provide you with a free copy of your credit report, but you must request it promptly. Otherwise each of the bureaus will provide you a copy of the report for a fee. You can request a copy from their web sites (see links above) or 800 numbers (also listed above).

Disputing Errors In Your Credit File

The Fair Credit Reporting Act (FCRA) protects consumers in the case of inaccurate or incomplete information in credit files. The FCRA requires credit bureaus to investigate and correct any errors in your file.

Tip: If you find any incorrect or incomplete information in your file, write to the credit bureau and ask them to investigate the information. Under the FCRA, they have about thirty days to contact the creditor and find out whether the information is correct. If not, it will be deleted.

Be aware that credit bureaus are not obligated to include all of your credit accounts in your report. If, for example, the credit union that holds your credit card account is not a paying subscriber of the credit bureau, the bureau is not obligated to add that reference to your file. Some may do so, however, for a small fee.

Fair Credit Reporting Act (FCRA)

This federal law was passed in 1970 to give consumers easier access to, and more information about, their credit files. The Fair Credit Reporting Act gives you the right to find out the information in your credit file, to dispute information you believe inaccurate or incomplete, and to find out who has seen your credit report in the past six months.

Understanding Your Credit Report

Credit reports contain symbols and codes that are abstract to the average consumer. Every credit bureau report also includes a key that explains each code. Some of these keys decipher the information, while others just cause more confusion.

Read your report carefully, making a note of anything you do not understand. The credit bureau is required by law to provide trained personnel to explain it to you. If accounts are identified by code number, or if there is a creditor listed on the report that you do not recognize, ask the credit bureau to supply you with the name and location of the creditor so you can ascertain if you do indeed hold an account with that creditor.

If the report includes accounts that you do not believe are yours, it is extremely important to find out why they are listed on your report. It is possible they are the accounts of a relative or someone with a name similar to yours. Less likely, but more importantly, someone may have used your credit information to apply for credit in your name. This type of fraud can cause a great deal of damage to your credit report, so investigate the unknown account as thoroughly as possible.

Note: An annual review of your credit report is recommended.

It is vital that you understand every piece of information on your credit report in order that you be able to identify possible errors or omissions.

Selling Your Home Without the Tax Hit

If you sold your main home, you may be able to exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) from your federal tax return. This exclusion is allowed each time that you sell your main home, but generally no more frequently than once every two years.

To qualify for this exclusion of gain, you must meet ownership and use tests.

Ownership Test: During the 5-year period ending on the date of the sale, you must have owned the home for at least 2 years.

Use Test: During the 5-year period ending on the date of the sale, you must have lived in the home as your main home at least 2 years. If you and your spouse file a joint return for the year of the sale, you can exclude the gain if either of you qualify for the exclusion. But both of you would have to meet the use test to claim the $500,000 maximum amount.

If you do not meet the ownership and use tests, you may be allowed to exclude a reduced maximum amount of the gain realized on the sale of your home if you sold your home due to health, a change in place of employment, or certain unforeseen circumstances. Unforeseen circumstances include, for example, divorce or legal separation, natural or man-made disasters resulting in a casualty to your home, or an involuntary conversion of your home.

If you can exclude all the gain from the sale of your home, you do not report the gain on your federal tax return. If you cannot exclude all the gain from the sale of your home, use Schedule D, Capital Gains and Losses, of the Form 1040 to report it.

Call us for more details and information, or see IRS Publication 523, Selling your Home.

IRS Changes Business Tax Filing Extension

Internal Revenue Service announced a change in the extended due date on certain business returns to help individuals better meet their filing obligations. The change, which reduces the extension period from six to five months, eases the burden on taxpayers who must report information from Schedules K-1 and similar documents on their individual tax returns.

Income, deductions and credits from partnerships, S corporations, estates and trusts are reported to partners, investors and beneficiaries on Schedules K-1 and other similar statements. The recipients then use that information to complete their own tax returns.

Currently, the extended due date for both businesses and individuals often falls on the same date, generally Oct. 15. This creates a burden for individual taxpayers who rely on the information from Schedule K-1 and other similar statements to prepare and file their personal tax returns in a timely manner.

Note: "We are eliminating the same-day deadline for these returns, which causes needless hardship and puts the individual taxpayer in an awkward position," said IRS Commissioner Doug Shulman. "We want to correct this timing issue to ensure that all taxpayers have the information they need to file timely and stay in compliance with the law."

The IRS issued temporary and proposed regulations that will reduce the extension of time to file tax returns for certain businesses that generate Schedules K-1 and other similar statements from six months to five. Requiring these statements to be issued one month earlier, generally by Sept. 15, will provide recipients time to prepare and file returns within the extended time frames.

This change will be effective for extension requests with respect to tax returns due on or after Jan. 1, 2009, and applies to business entities that file the following returns and forms that have a tax year ending on or after Sept. 30, 2008:

The regulation does not change the process for requesting an extension of time to file, nor does it affect extensions of time to file other types of business returns, such as those used by S corporations.

The IRS initiated the proposal to reduce the extension of time to file, carefully weighing the impact on partnerships and other affected entities against the burden the existing deadline puts on individuals, who need this information to file timely and accurate returns.

What to do if You Haven't Filed Your 2007 Return

The failure to file a federal tax return can be costly — whether you end up owing more or missing out on a refund.

Note: Getting it done for the 2007 tax year is important because in order to receive your 2008 Economic Stimulus Payment this year you need to file a 2007 federal tax return by October 15, 2008.

There are several reasons taxpayers don’t file their taxes. Perhaps you didn’t know you were required to file. Maybe, you just kept putting it off and simply forgot. Whatever the reason, it’s best to file your return as soon as possible. If you need help, even with a late return, the IRS is ready to assist you.

Here are some things to consider:

Whether or not you must file a tax return will depend upon a number of factors, including your filing status, age, and gross income.

Please call us for more information on how to file a tax return for a prior year.

IRS Offers Basic Hints to Help New Small Business

One of the biggest challenges facing people who are starting their own small business is understanding and meeting the tax filing requirements. It can be an overwhelming experience to learn about federal tax responsibilies and to avoid common pitfalls.

The following is a list of the basic tips offered by the IRS to avoid potential problems:

Use Accounting Ratios to Stave Off Financial Problems

Does the mere mention of accounting ratios may put your teeth on edge, and bring back bad memories of Accounting 101? It shouldn’t as ratios can help your quickly determine how your business compares against others.

Banks often use ratios to analyze your financial statements as part of the loan approval process, so it’s helpful to know in advance how you’ll be measured. Even better, ratios allow you to compare your business against your peers since many trade groups publish lists of average ratios within an industry.

Although ratios may have made you drowsy during accounting class, they can be a fascinating way to measure your company’s financial performance.

Gross Profit Margin

Simply put, gross profit margin—sometimes referred to as gross margin—is your revenues less your cost of sales. For some industries, this is a very meaningful metric, while it won’t mean as much to others. For instance, manufacturers, restaurants, and retailers often treat gross profit as a key performance indicator.

In such environments, one typically purchases inventory at one price, and ideally sells it to someone else at a higher price. The spread between these two numbers is the gross profit margin.

Let’s say that you buy $40 of pine straw (we’re trying to avoid the accounting class term widget) and sell it for $60. In this case, $20 of gross margin divided by $60 of sales yields a gross margin percentage of 33%. Thus one-third of your sales are available to put toward overhead items, such as office supplies, payroll, rent, taxes, and so on.

Ideally your gross margin is high enough to cover your overhead and leave you with a profit. With that example in mind, let’s see how you can calculate your own gross profit margin.
Caveat: Gross profit margin isn’t meaningful to everyone. For instance, if you’re a self-employed service provider, you may not have any cost of sales.

Your salary is arguably all or most of your profit. You can certainly count your salary as cost of sales and compute a gross profit margin, but you might not find much value in the result.

To begin, choose Reports, Company and Financial, and then Profit & Loss Standard. As shown in Figure 1, look for the Gross Profit amount, and then divide this by Total Income.

Figure 1: The Profit and Loss Standard report provides the figures you need to calculate gross profit.

In this case, $30,953.20/$51,241.16 shows a gross profit margin of 60.4%. Is that good? Is it bad? Very often the answer is “it depends”, which is why you should try to compare yourself to similar companies in your industry.

However, let’s consider the restaurant industry. Many owners strive to keep their gross margin at around 63%, which means a cost of goods sold percentage of 37%. The gross profit ratio enables you to track this key measurement, but you must ensure that your transactions are being recorded in the proper accounts.

The percentages can skew if, let’s say a telephone bill, is miscoded to Food Costs, instead of Telephone. Similarly, your cost of goods sold might look great only because someone miscoded food costs into an overhead account, such as Supplies.

Profit Margin

Profit margin is another commonly used ratio that you can derive from the Profit & Loss Standard report by dividing Net Income by Total Income. In essence, this is the percentage of sales that the owner of a business gets to keep—before Uncle Sam gets his share. Profit margins vary widely by industry.

For example, a grocery store chain may have profits of $2 billion, but a profit margin of just 2.6%. An oil company may have staggering profits in dollars, but their profit margin is often just 10%. Conversely, some software companies have a profit margin of 28% or more.

As with gross profit, the best way to determine whether a profit margin is reasonable is by comparing the result to one’s peers. The construction company shown in Figure 1 has Net Income for the period of $13,123.48, which when divided by Total Income of $51,241.16 returns a profit margin of 25.6%.

Inventory Turnover Ratio

This ratio illustrates how many times a year that you’re selling your entire inventory. This can help you gauge whether you may be holding too much inventory, or not enough. This ratio is based on cost of goods sold divided by average inventory.

As you’ve seen, cost of goods sold appears on the Profit and Loss Standard report—look for Total COGS—but you’ll have to perform a quick calculation to determine average inventory. To do so, divide the sum of your beginning inventory plus ending inventory by 2.

Although you can use several different reports in QuickBooks to determine the beginning and ending balance of your inventory, try this first: choose Reports, Company and Financial, and then Balance Sheet Prev Year Comparison.

Change the report date to This Fiscal Year, and then look for the inventory account balance, as shown in Figure 2.The ending balance for last year is also the beginning balance for this year.

If you need beginning and ending balances for a shorter period, such as a quarter, choose Reports, Accountant and Taxes, and then General Ledger. Set the report dates to the period of your choice, and then use the beginning and ending balances for your inventory account.

Figure 2: The Balance Sheet Prev Year Comparison can provide beginning and ending inventory balances.

Average Collection Period

This ratio helps you determine how long it takes your customers to pay their invoices. The formula is a little more complex than some of the other ratios: number of days multiplied by average accounts receivable balance, divided by credit sales.

For instance, let’s say that your average accounts receivable balance is $30,000, and you had total sales of$400,000 for the year. 365 multiplied by 30,000 is 10,950,000. This amount divided by our total sales of $400,000 is 27.38, meaning that on average your customers pay their invoice in just under 30 days.

Be sure to monitor your average collection period, as your cash flow can tighten quickly if that ratio increases. If you typically invoice your customers, then you can use the Total Income figure from your Profit & Loss Standard report.

Keep in mind: Average collection period won’t be of interest if your customers pay on the spot, such as in a retail store or restaurant.

Although QuickBooks doesn’t directly provide a figure for average accounts receivable, you can quickly customize a report to aid in this calculation:

Figure 3: Change Display Columns By to Months when you want a month-by-month report.

When QuickBooks displays the 12-month report, as shown in Figure 4, click the Export button, and then click OK to send the report to Microsoft Excel.

Figure 4: You can convert the Balance Sheet Standard report into a twelve-month format.

As shown in Figure 5, row 9 contains the Accounts Receivable figures. In cell R9, enter this formula to calculate your average accounts receivable balance: =AVERAGE(F9:R9).

Figure 5: Use the Accounts Receivable figures to calculate your average accounts receivable balance.

As you can see, the average collection period ratio enables you to determine how long it takes your customers to honor your invoices, which in turn has a direct impact on your cash flow.

Other Common Ratios

Current Ratio: Divide current assets by current liabilities to determine a firm’s liquidity.

Quick Ratio: Subtract inventory from current assets, and then divide by current liabilities to apply a more severe liquidity measurement.

Debt Ratio: Divide total debt by total assets to determine how much of the company is financed by debt.
Return On Assets: Banks often add net income plus interest expense together, and then divide this by total assets to determine the firm’s return on assets. This figure typically needs to exceed the interest rate of a loan that you may be contemplating.

Compare Yourself to Others

Now that you understand how to calculate ratios based on your financial results, the next step is to compare yourself to your peers. You may belong to a trade group that makes benchmarks available to its members. If not, a good first step is the BizStats web site, at www.bizstats.com.

Your line of business may be included in their free offerings, but even more information is available on a subscription basis. You can find even more resources by searching the Internet search for the term “industry benchmarks”.

Did You Know?

You can send your thoughts about QuickBooks to Intuit directly from within QuickBooks. To do so, choose Help, Send Feedback Online, and then one of these choices:

Any of these links will display an online from in your web browser so that you can submit your thoughts directly to the QuickBooks development team. QuickBooks frequently updates its’ products, so before you send a bug report, choose Help, and then Update QuickBooks. Click the Update Now button to ensure that you have the latest patches and fixes for your version of QuickBooks.

Figure 6: Submit your wish-list items directly to the development team from within QuickBooks.

Financial Planning Tips for August 2008

Prepare a Post Mortem Letter

Review or prepare a "post-mortem" letter to your spouse spelling out the location of your assets and property (assets of a deceased are often lost because a spouse may not be aware of them or know their location), the names of all your advisors, and any other information your spouse should know to minimize his or her burden in the stressful period after your death.

Get Your Social Security Statement of Benefits

Request a Personal Earnings and Benefit Estimate Statement from the Social Security Administration. This can be done using Form SSA-7004 or over the Internet. This statement summarizes your social security earnings history and provides an estimate of the benefits to which you are entitled. It is important to verify that you have been credited for all of your earnings. You can also use this statement in your retirement planning.

Review Your Budget vs Actuals for July

Compare July income and expenditures with your budget. Make adjustments as appropriate to your August expenditures. Make sure you have invested your planned savings amount for July.

Estimate Your Tax Liability

Total up your taxable income, capital gains and deductions through this date. This information can be used to plan your estimated tax payments, and perhaps avoid or minimize any underpayment penalties.

Tax Due Dates for August 2008