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.

The Internal Revenue Service announced an increase in the standard mileage rates for the final six months of 2008. The rate increases to 58.5 cents a mile for all business miles driven from July 1, 2008, through Dec. 31, 2008. This is an increase of 8 cents from the 50.5 cent rate in effect for the first six months of 2008.

In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2008. The IRS normally updates the mileage rates once a year in the fall for the next calendar year.

"Rising gas prices are having a major impact on individual Americans. Given the increase in prices, the IRS is adjusting the standard mileage rates to better reflect the real cost of operating an automobile," said IRS Commissioner Doug Shulman. "We want the reimbursement rate to be fair to taxpayers."

While gasoline is a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance and other fixed and variable costs.

The business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

The mileage reimbursement rate for computing deductible medical or moving expenses for the last six months of 2008 also increased by 8 cents to 27 cents a mile, up from 19 cents for the first six months of 2008. The rate for providing services for charitable organizations is set by statute, not the IRS, and remains at 14 cents a mile.

For tax purposes, you always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

Mileage Rate Changes

The Mileage Log Requirement

Recordkeeping is an important element of claiming the standard mileage rate or actual costs of using a vehicle for business. A mileage log should be maintained for any vehicle used for business purposes. The log should be kept in the car for ready access. The mileage log should contain the following information for each business trip (or medical or charitable trips):

1. Date of trip
2. Business purpose for the trip
3. Location of start and finish to the trip
4. Miles driven for business purposes
5. Other expenses incurred such as parking and tolls

The vehicle log can also contain record of gasoline purchases, maintenance, oil changes, car insurance, car wash costs and auto club memberships for the year. This will allow you to determine the actual cost of operating your vehicle. Claiming actual costs is an alternative to the standard mileage reimbursement.

Employees often grumble about their "use it or lose it" health plans. In this article, we'll give you some alternatives to consider.

The amounts that are "lost" if not "used" are amounts set aside for health care in a cafeteria plan or other salary reduction arrangement. It's a way to avoid tax on amounts an employee spends on medical care. If the employee paid the medical expenses directly out of salary, he or she would owe tax on the full salary, with little chance of deducting the expenses under today's rule limiting deductions to amounts in excess of 7.5% of adjusted gross income (AGI). But an employee in a cafeteria plan may set part of the year's salary aside for medical bills, and not have to pay tax on the amount they set aside.

Example: Assume Janet's salary (and AGI) is $60,000, and she has $4,000 of medical expenses. If she pays medical bills out of salary, she has no medical deduction and her tax is $11,665. But in a cafeteria plan, she could allocate $4,000 to those medical bills and pay tax on only $56,000, for a tax of $10,665, a $1,000 after-tax saving.

The Problem

The amount you will set aside for medical expenses generally must be determined before the start of the year (or before you join the plan, if later). The choice can't be changed later in the year, except upon changes in family size and the like. What you have set aside that you don't use for medical care can't come back to you, then or later. That's the "use it or lose it" problem. If Janet in our example had spent $3,000 on medical bills instead of the $4,000 set aside, she would get no refund of the unspent $1,000.

"Use it or lose it" pushes some employees into a frenzy of year-end outlays, to spend their account balances on whatever might qualify as a medical expenditure, such as designer eyeglasses.

Note: Some employees wonder what happens to amounts they "lose". These amounts don't go back to the employer-or not exactly. The employer can distribute forfeited amounts as "dividends" to participants generally (not based on the amount, if any, the dividend recipient forfeited) or use them in other ways for medical expenses of participants generally.

There's a technical legal reason for "use it or lose it". The general tax rule is that if your employer gives you a choice to take either cash or a tax-free employee benefit, you are taxed on the cash whichever you actually choose. Cafeteria plans are an exception, but only if you make your choice of the tax-free benefit before the year (or your participation) begins.

Don't blame IRS for "use it or lose it". Blame Congress, if anyone. It's in the law and some lawmakers want to change it. (But not the Bush Administration, which instead is pushing health savings accounts, discussed later.)

What's the solution? Many recognize that "use it or lose it" causes waste of medical care dollars, by provoking marginal medical expenditures at year-end. A recent IRS ruling refines the "health reimbursement arrangement" (HRA), which IRS designed as a partial cure. Here, an employer may offer employees a fixed sum or percentage of pay in a personal account, from which employees withdraw for medical expenses. Amounts they don't use can carry over for medical expenses in later years, to add to whatever the employer may contribute in those years. Any balance left in the account at the employee's retirement can be used for health care in retirement, including health care for a spouse, surviving spouse, and dependents.

Does the HRA solve the problem? Well, not for everyone. The "use it or lose it" rule applies to cafeteria plans, which may run entirely on the employee's money (through salary reductions). HRAs must run on the employer's money (employer contributions on top of employee pay), so some employers will stay away.

Note: The new IRS ruling okays the partial forfeiture (to the employer) of the unused balance and carryover of the rest. Their thinking must be that the partial forfeiture reduces the employer's cost, but the partial carryover feature still encourages employees to be cost-conscious, since the more that's unspent, the more that carries over for future use.

Health Savings Account (HSA)

Health Saving Accounts, which began in 2004, lets you make tax-deductible contributions to your own IRA-like savings account, if you have high-deductible health insurance (HDHI). Amounts you withdraw from the account for medical bills are tax-free, so in effect your medical expenses - apart from HDHI premiums - are fully deductible. With a HSA, you are paying the full cost of your health care (with tax relief), but your employer, if it wants to, can share your cost by contributing to your HSA or your HDHI premium.

For employees but even more for employers, health care plans can be a maze. Do you as employer want a cafeteria plan run through the company at (entirely or partly) the employee's expense, as with the "use it or lose it" feature? Or as a HRA, running through the company at the company's expense? Or as a HSA, running through the employee at the employee's expense, but maybe with an employer contribution?

Tip: Health care plan design may be today's most complex and costly employee benefit challenge. Please call us for professional guidance.

The Kiddie Tax rules changed for tax year 2008. In May 2007, Congress amended the Kiddie tax rules again as part of the Iraq spending bill. The Kiddie Tax age limit increased for 2008 to affect children's investment income through age 18 and full-time students through age 23. The prior rules impacted children's investment income through age 17.

History of the Kiddie Tax

The Kiddie Tax was first established in 1986 to keep parents from shielding income by placing investment accounts in the names of their children, who typically were in lower income tax brackets. Under the Kiddie Tax, a portion of the investment earnings held in a child's name was tax free, the next portion was taxed at the child's marginal tax rate and any amount over the second earnings limit was taxed at the parents' marginal tax rate.

The initial Kiddie Tax rules expired when a child turned 14. The age level was increased to 18 (through age 17) under the Tax Increase Prevention and Reconciliation Act of May 17, 2006. This revision was retroactive to January 1, 2006.

In 2008, this age threshold further increased to cover children through age 18 and full time students through age 23. To be considered a full-time student, a child must be enrolled full-time in school for at least five calendar months in the year.

The Kiddie Tax now ceases to exist at the beginning of the year the child turns 19 (or 24 for full-time students). From this year forward, the child is taxed as any unmarried taxpayer. Further, it should be noted that the Kiddie Tax does not apply to married couples filing a joint return.

Kiddie Tax Facts:

• It affects children through age 18 or 23 for full-time students.

• It only applies to unearned income, which is typically investment income held in the child's name. Income from other sources, such as employment, is not affected by the Kiddie tax.

• For 2008, only unearned income over the annual earnings limit of $1,800 is taxed under the Kiddie Tax rules.

• Kiddie Tax does not apply to married couples filing a joint return.

• Kiddie Tax does not apply if the earned income of a student over age 18 exceeds half of the child's living expenses. Living expenses include food, housing, clothing, medical, dental, education and other necessary costs of support. Students over 18 are considered independent from their parents if they provide more than 50% of their own support.

Calculation of the Kiddie Tax

As noted earlier, the first portion of unearned income is tax free. In 2008, this amount is $900. The next $900 in investment income is taxed at the child's tax rate. This rate can be as low as 5% on long-term capital gains and dividends and no more than 10% or 15% for short-term capital gains and interest. Any income above $1,800 is taxed at the parents' rates - 15% for dividends and long-term capital gains and as much as 35% on short-term capital gains and interest. The stated investment income levels ($900 tax free, etc.) will be periodically adjusted for inflation in future years.

Earned vs Unearned Income

It is important to understand that the Kiddie Tax only applies to unearned income, typically investment income. Income earned through employment, such as weekend jobs or part-time work, is taxed at the child's marginal tax rate with no Kiddie Tax impact. A child will pay no tax on earned income up to $5,450 in 2008 due to the standard deduction. The standard deduction amount will increase with the annual inflation adjustment.

Filing of the Kiddie Tax

If the Kiddie Tax affects your child, you will need to complete IRS Form 8615 to calculate the amount of the Kiddie Tax. This form is then filed with your child's Annual Tax Return - Form 1040.

Parents can alternatively elect to report child's unearned income on their return. A parent of a child under 19 can do this by filing IRS Form 8814 with your Form 1040 and paying the entire federal income tax (including the Kiddie Tax). This option, however, is only available if your child's income is solely unearned income from interest, dividends and capital gain distributions and is no more than $8,500. If the parent makes this election, the child does not have to file a return.

Example: Despite the change in the age limits, there are still savings by placing investments in your child's name. For example, your 16 year old generated $6,000 in investment income in 2008. The first $900 is tax free, the second $900 at 10% (interest and short term gains or 5% for dividends and long term gains) and the next $4,200 at the parents' marginal tax rate in this example - 35% (or 15% for long term capital gains). The tax due on the $6,000 is $1,560. Under the parents' rate, the tax due would be $2,100 or a difference of $540 per child.

Related Financial Guide: IRS Publication 929 - Tax Rules for Children and Dependents

As another school year ends, college tuition payments are now another year closer. Parents often wonder when they should start saving and how much.

College tuition and fees are costly and on the rise. Even with 4-year private schools running on average $32,000 per year, the cost is well worth it. According to the US Census Bureau, individuals with a bachelor's degree earn more than double those with just a high school diploma.

How much to save depends on how much you think your child's education will cost. The best way is to start saving before they are born. The sooner you begin, the less money you will have to put away each year.

Example: Suppose you have one child, age six months, and you estimate that you'll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you'll need to save $3,500 per year for 18 years (assuming an after-tax return of 7%). On the other hand, if you put off saving until the child is six years old, you'll have to save almost double that amount every year for twelve years.

Another advantage of starting early is that you'll have more flexibility when it comes to the type of investment you'll use. You'll be able to put at least part of your money in equities, which, although riskier in the short-run, are better able to outpace inflation than other investments in the long-run.

Financial Calculator: College Savings Planner
Use this calculator to help develop and fine tune your child's college education savings plan.

How Much Will a College Education Cost?

Based the survey completed for the 2007 Trends in College Pricing, the average cost for tuition, fees, room and board for 2007-2008 was:

$13,589 per year for 4-year public (in state) colleges and universities.
This is an increase of 5.9% from 2006-2007 findings

$32,307 per year for 4-year private colleges and universities.
This is an increase of 5.9% from 2006-2007 findings

It should also be noted that on average, full-time students receive $9,300 of financial aid per year in the form of grants and tax benefits for private 4-year institutions, $3,600/yr for public 4-year institutions, and $2,040/yr for public 2-year institutions.

Section 529 Qualified Tuition Plans

Many parents are looking at ways to save for college. In 2000, Section 529 plans, also known as Qualified Tuition Programs (QTP) became a popular college savings vehicle for parents.

Every state now has a program allowing persons to prepay for future higher education, with tax relief. There are two basic plan types, with many variations among them:

1. The Prepaid Education Arrangement. Where one is essentially buying future education at today's costs, by buying education credits or certificates. This is the older type of program, and tends to limit the student's choice of schools within the state.

2. Education Savings Accounts. Where contributions are made to an account to be used specifically for future higher education.

Tip: When approaching state programs one must distinguish between what the federal tax law allows and what an individual state's program may impose.

You may open a Section 529 program in any state. But when buying prepaid tuition credits (less popular than savings accounts), you often need to apply the credits to a specific college or group of colleges.

Unlike certain other tax-favored higher education programs, such as the Hope and lifetime learning tax credits, federal tax law doesn't limit the benefit only to tuition. Room, board, lab fees, books, and supplies can be purchased with funds from your 529 Savings Account. (Individual state programs could be narrower.)

The two key individual parties to the program are the Designated Beneficiary, the student-to-be, and the Account Owner, who is entitled to choose and change the beneficiary and who is normally the principal contributor to the program.

There are no income limits on who may be an account owner. There's only one designated beneficiary per account. Thus, a parent with three college-bound children might set up 3 accounts. (Some state programs don't allow the same person to be both beneficiary and account owner.)

Contributions must be in cash, and must not total more than reasonably needed for higher education (as determined initially by the state). Neither account owner nor beneficiary may direct investments, but the state may allow the owner to select a type of investment fund (e.g., fixed income securities), and to change the investment annually, and when the beneficiary is changed. The account owner decides who gets the funds (can pick and change the beneficiary) and is legally allowed to withdraw funds at any time, subject to tax and penalty discussed later.

Funds in the account not yet distributed at the account owner's death pass as part of the probate estate under state law-though this is not the result for federal estate tax purposes, see below.

Federal Tax Rules Relating to 529 College Savings Plans

Income Tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes. Earnings on contributions grow tax-free while in the program.

Distributions from the fund are tax-free to the extent used for qualified higher education expenses. Distributions used otherwise are taxable to the extent of the portion which represents earnings.

A Section 529 distribution can be tax-free even though the student is claiming a Hope or lifetime learning credit, or tax-free treatment for a Section 530 Coverdell distribution, if the programs aren't covering the same specific expenses.

Distribution for a purpose other than qualified education is taxed to the one receiving the distribution. In addition, a 10% penalty must be imposed on the taxable portion of the distribution, comparable to the 10% penalty in Section 530 Coverdell plans.

The account owner may change beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them. Thus they qualify for the up-to-$12,000 annual gift tax exclusion ($11,000 before 2006). One contributing more than $12,000 may elect to treat the gift as made in equal installments over the year of gift and the following 4 years, so that up to $60,000 can be given tax-free in the first year.

A rollover from one beneficiary to another in a younger generation is treated as a gift from the first beneficiary, an odd result for an act the "giver" may have had nothing to do with.

Estate Tax. Funds in the account at the designated beneficiary's death are included in the beneficiary's estate, another odd result, since those funds may not be available to pay the tax. Funds in the account at the account owner's death are not included in the owner's estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $12,000. For example, if the account owner made the election for a gift of $60,000 in 2008, a part of that gift is included in the estate if he or she dies within 5 years.

Tip: A Section 529 program can be an especially attractive estate-planning move for grandparents. There are no income limits, the account owner giving up to $60,000 avoids gift tax, and estate tax by living 5 years after the gift, yet has the power to change the beneficiary.

State Tax. State tax rules are all over the map. Some reflect the federal rules, some quite different rules. For specifics of each state's program, see http://www.collegesavings.org.

Professional Guidance

Considering the wide differences among state plans, the federal and state tax issues, and the dollar amounts at stake, please call us before getting started with a 529 plan.

Related Financial Guide: IRS Publication 970, Tax Benefits for Higher Education

What is Estimated Tax?Estimated tax is the method used to pay tax on income that is not subject to withholding, such as self-employment income, interest, dividends, rents, alimony, etc. In addition, if you do not elect voluntary withholding, you should make estimated payments on other taxable income, such as unemployment income and the taxable portion of social security benefits.

Who needs to pay estimated taxes?In most cases, you must make estimated payments if you expect to owe at least $1,000 in tax in 2008 and you expect your withholding and credits to be less than the smaller of:

1. 90% of the tax shown on your 2008 tax return, or
2. 100% of the tax shown on your 2007 tax return. Note exceptions apply for higher income taxpayers. Further, if you did not file a 2007 tax return or if your 2007 return did not cover the full 12 months, the 100% rule does not apply.

Special Rules

Higher income taxpayers: If your adjusted gross income for 2007 was more than $150,000 ($75,000 if your filing status for 2008 is married filing separately) substitute 110% for 100% in Rule #2. This rule does not apply to farmers or fishermen.

Farmers and Fishermen: If at least two-thirds of your gross income in 2007 or 2008 is from farming or fishing, substitute 66 2/3% for 90% in Rule #1.

Summer is wedding time. If you are getting married this summer, you will need to consider your 2008 tax filing status.

You have two filing status options: Married filing jointly or Married, filing separately.

Married Filing Jointly

You can choose married filing jointly as your filing status if you are married and both you and your spouse agree to file a joint return. On a joint return, you report your combined income and deduct your combined allowable expenses. You can file a joint return even if one of you had no income or deductions.

According to the IRS, if you and your spouse decide to file a joint return, your tax may be lower than your combined tax for the other filing statuses. Also, your standard deduction (if you do not itemize deductions) may be higher, and you may qualify for tax benefits that do not apply to other filing statuses.

We recommend that if you and your spouse each have income, you may want to figure your tax both on a joint return and on separate returns (using the filing status of married filing separately). You can choose the method that gives the two of you the lower combined tax.

Joint Responsibility - Both of you may be held responsible, jointly and individually, for the tax and any interest or penalty due on your joint return. One spouse may be held responsible for all the tax due even if all the income was earned by the other spouse.

Married Filing Separately

You can choose married filing separately as your filing status if you are married. This filing status may benefit you if you want to be responsible only for your own tax or if it results in less tax than filing a joint return.

A Coverdell Education Savings Account is an account created as an incentive to help parents and students save for education expenses.

The total contributions for the beneficiary of this account cannot be more than $2,000 in any year, no matter how many accounts have been established. A beneficiary is someone who is under age 18 or is a special needs beneficiary.

The beneficiary will not owe tax on the distributions if they are less than a beneficiary's qualified education expenses at an eligible institution. This benefit applies to higher education expenses as well as to elementary and secondary education expenses.

Here are some things to remember about Distributions from Coverdell Accounts:

• Distributions are tax-free as long as they are used for qualified education expenses, such as tuition, books and fees

• There is no tax on distributions if they are for an eligible educational institution. This includes any public, private or religious school that provides elementary or secondary education as determined under state law

• The Hope and lifetime learning credits can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits

• If the distribution exceeds education expenses, a portion will be taxable to the beneficiary and will be subject to an additional 10% tax. Exceptions to the additional 10% tax include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship

There are contribution limits for taxpayers based on the taxpayer's Modified Adjusted Gross Income. Contributions to a Coverdell ESA may be made until the due date of the contributor's return, without extensions.

If there is a balance in the Coverdell ESA at the time the beneficiary reaches age 30, it must be distributed within 30 days. A portion representing earnings on the account will be taxable and subject to the additional 10% tax. The beneficiary may avoid these taxes by rolling over the full balance to another Coverdell ESA for another family member.

Call us for more information, or see IRS Publication 970, Tax Benefits for Higher Education.

If you use a portion of your home for business purposes, you may be able to take a home office deduction whether you are self-employed or an employee. Expenses that you may be able to deduct for business use of the home may include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, depreciation, painting and repairs.

You can claim this deduction for the business use of a part of your home only if you use that part of your home regularly and exclusively:

• As your principal place of business for any trade or business

• As a place to meet or deal with your patients, clients or customers in the normal course of your trade or business

Generally, the amount you can deduct depends on the percentage of your home that you used for business. Your deduction will be limited if your gross income from your business is less than your total business expenses.

If you use a separate structure not attached to your home for an exclusive and regular part of your business, you can deduct expenses related to it.

If you are self-employed, use Form 8829 to figure your home office deduction and report those deductions on line 30 of Schedule C, Form 1040. There are special rules for qualified daycare providers and for persons storing business inventory or product samples.

If you are an employee, you have additional requirements to meet. The regular and exclusive business use must be for the convenience of your employer.

Call us for more information, or see IRS Publication 587, Business Use of Your Home.

If you're like most QuickBooks users, you rely on the Profit & Loss Standard report to monitor how your business is doing. However, you may have overlooked an even more valuable report: the Statement of Cash Flows.

The Profit & Loss Standard (P&L) report is important in its own right, but it only provides partial insight into the health of your business. While the P&L shows what you earned and spent, the Statement of Cash Flows shows you where the cash came from and went to, also known as sources and uses.

As you'll see in this article, you can use the Statement of Cash Flows to determine the how various activities increased or decreased your cash balance during a given report period.

Cash versus Accrual

Unlike some accounting packages, QuickBooks allows you to run most reports on either the cash or accrual basis.

Cash-basis means that transactions don't appear on your Profit & Loss statement until either your customer pays their invoice or you pay a vendor (or employee). So, if you enter a bill in QuickBooks to be paid later, the expense won't immediately appear on a cash-basis P&L.

Similarly, invoices that you send to customers won't immediately appear on a cash-basis P&L. The expense appears when you write a check to the vendor, and the revenue appears when the customer honors their invoice. Accordingly, cash-basis reports don't necessarily report a company's true financial performance.

You could have a stellar looking Profit & Loss Report, but a list full of unpaid bills in QuickBooks. Accordingly, many accountants prefer that business owners use accrual-basis reports.

Accrual-basis reports recognize the effect of every transaction on your P&L immediately. Customer invoices appear on accrual-basis P&L reports as soon as you save the transaction, as do unpaid vendor bills. You can easily see the significance of these differences in Figures 1 and 2.

Figure 1: Cash-basis reports only reflect paid transactions.

Figure 2: Accrual-basis reports include all transactions - both paid and unpaid.

Accrual-basis reports provide a much better picture of where the business stands, but can make it harder to understand your current cash position. However, a cash-basis P&L isn't a panacea for managing cash flow, as your business has many transactions that don't affect the P&L.

For instance, loan payments, owner distributions, and owner contributions affect your balance sheet, which tracks assets, liabilities, and equity. Fortunately, the Statement of Cash Flows reflects these types of transactions and more, so it's a great companion to both cash-basis and accrual-basis P&L reports.

Set Your Preference

You can instruct QuickBooks to always display your reports on either cash or accrual basis:

• Choose Edit, and then Preferences.
• Choose Reports & Graphs, and then Company Preferences.

As shown in Figure 3, specify either Cash or Accrual, and then click OK.

Figure 3: You can set either cash or accrual as your default report format.

Of course, at any time you can change a report to the other format. For instance, if your preference is set to accrual, but you may sometimes want to view a cash basis P&L:

• Choose Reports, Company & Financial, and then Profit & Loss Standard.
• Click the Modify Report button, and then choose Cash in the Report Basis section, as shown in Figure 4.

Figure 4: You can change the accounting method for your P&L on the fly.

NOTE: Most, but not all, reports in QuickBooks allow you to change between cash and accrual. When a report is onscreen, choose Modify Report.

If you don't see the Report Basis section, shown in Figure 5, then you'll know that you can't toggle the report basis. Now that you understand the ins-and-outs of running cash and accrual basis reports, let's explore the Statement of Cash Flows.

The Statement of Cash Flows

Let's say that your cash balance at the beginning of your fiscal year was $100,000, and today it is $75,000. The net income figure on your P&L won't give you the full details on why your cash balance decreased, but the Statement of Cash Flows will. To do so, choose Reports, Company & Financial, and then Statement of Cash Flows.

Report periods: As shown in Figure 5, this report automatically defaults to This Fiscal Year-To-Date, but you can choose another time period if you wish. To do so, make a choice from the Dates drop-down list, or modify the From and To dates, and then click the Refresh button.

Figure 5: The Statement of Cash Flows defaults to the current fiscal year.

Your Statement of Cash Flows report will include up to three major sections:

• Operating Activities
• Investing Activities
• Financing Activities

Don't worry if your report only includes one or two of these sections - sections only appear when you had relevant transactions during the report period. Let's explore each of these sections individually.

Operating Activities

The Operating Activities section of the Statement of Cash Flows recaps activities related to running your business. This section will always start with Net Income, followed by an adjustments section.

The adjustments reconcile your net income with the net cash provided by the operating activities. For instance, refer to Figure 5. Net income s $112,999 but the Net Cash Provided by Operating Activities is $42,584. Accordingly, the statement of cash flows identifies the $70,415 difference. Let's investigate a couple of the items:

Inventory Asset (-$17,354): Amounts that we spend on inventory don't become part of Net Income until we've sold the items. At that point QuickBooks posts the expense to cost of good sold, and reduces our inventory account accordingly. Purchasing inventory is a use of cash, so it appears as a negative amount on our Statement of Cash Flows.

Remember: The purpose of the Statement of Cash Flows is to reconcile our net income with the actual change in our cash account. Thus non-cash activities, such as unpaid customer invoices or amortized prepaid expenses get subtracted or added from Net Income, so that you can get a clear picture of where cash went during the report period.

Employee Advances (-$62): We paid $62 to an employee as an advance, which has not yet been repaid. This amount isn't included in Net Income, but is a use of cash, so the amount is deducted. When our employee repays the advance, our Statement of Cash Flows will reflect a positive amount, since at that point we'll have a $100 source of cash.

Prepaid Insurance ($893): During the report period we amortized, or used up, $893 of prepaid insurance. This expense is included in our Net Income figure, but we didn't write a check for it during this report period, so QuickBooks adds this expense back.

Accounts Payable ($13,537): We've entered bills into QuickBooks totaling $13,537 that we haven't paid yet. In effect, we're temporarily borrowing this money from our vendors, so it's a source of cash. Later, our Statement of Cash Flows will show a use of cash when we pay the vendor bills. This same treatment applies to credit cards and other liabilities.

As you look through the Statement of Cash Flows, you may also see Investing and Financing activities. Investing activities may include owner contributions as a source of cash, or in the case of the report in Figure 5, the purchase of $11,500 in furniture as a use of cash.

Financing activities will show borrowing on a line of credit or other loan as a source of cash, while loan repayments (net of interest) will appear as uses of cash. In the end, you'll see exactly what caused your cash balance to increase or decrease during the report period.

Research: You can easily investigate why amounts appear on your Statement of Cash Flows. As shown in Figure 6, the QuickZoom icon appears when you hover over an amount. Double-click to display a detailed report, as shown in Figure 7.

Figure 6: The QuickZoom icon indicates that you can drill-down within a QuickBooks report.

Figure 7: A detailed report appears when you double-click on an amount within a QuickBooks report.

Organizing the Statement of Cash Flows

QuickBooks makes an educated guess at what accounts in your chart of accounts should appear on the Statement of Cash Flows. However, you may encounter instances where activities appear in the wrong section, or don't appear at all on the report. You can easily remedy such situations:

• Choose Edit, and then Preferences.
• Choose Reports & Graphs, and then Company Preferences.
• Click the Classify Cash button, shown in Figure 3.

As shown in Figure 8, place a checkbox in the appropriate column. You cannot remove balance sheet accounts from the statement, but you can optionally include income and expense accounts. However, keep in mind that this is not a typical need, and you should only proceed under the guidance of your accountant or tax advisor.

Figure 8: QuickBooks allows you to classify accounts as operating, financing, or investing activities.

Did You Know?

QuickBooks has a Product Information window that can provide a dizzying array of information. Press Ctrl-1 to display the window shown in Figure 9. Some key elements on this screen include the product number shown at the top.

Each QuickBooks user in your office should have the same release number. The size and location of your QuickBooks file is shown in the File Information section, while you can use the List Information section to determine how many customers and vendors you have in QuickBooks.

Figure 9: Press Ctrl-1 to view the Product Information window.

Estate Plan Checkup
Give thought to your estate plan. How do you intend your assets to be distributed at your death? Federal estate tax may be a factor. Please call us for guidance concerning ways of minimizing estate taxes and probate costs, so that the maximum amount goes to your desired beneficiaries.

Examine Property Tax Bills
Examine your property tax bills and explore the possibility of challenging the valuation.

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

Investment Review
Review your investment performance for the first half of the year. Consider reallocating under-performing or low-yielding assets.

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