With most young companies cash is king. As a company grows managing the cash available to finance that grow is crucial to sustaining the growth rate. Minimizing the cash expenses of the company is an entrepreneurs and CFO’s primary job. One of the main cash expenses is federal income taxes.
Don’t Let Tax Strategies Drive Financial Performance
During this start up and growth phase (which can last 10 years or more) the entrepreneur is focused on minimizing the cash payments for federal income taxes. He will work closely with his tax CPA to aggressively take financial positions that minimize taxes.
Somewhere along the line this strategy begins to lose its effectiveness. It generally happens when outside bank financing is obtained to fuel the growth of the company. As larger and larger amounts of outside debt is obtained the financial reporting needs of the company changes. The financial statements must now be presented to new users (i.e. the bank). The banks are seeking a clearing picture of the financial position of the company on an accrual basis. Often they want to know the true equity available from the company so they can establish the leverage of the company.
But maximizing the equity value of the company often is at odds with minimizing federal income taxes. To minimize taxes you typically end up either taking deductions sooner, deferring the recognition of income or valuing assets more conservatively. Taking these positions is fine until you want to borrow money.
Most entrepreneurs want to borrow as much as they can to fuel growth. However, by presenting there financial statements on a tax basis they minimize the amount that lenders will advance.
Conclusion on Tax Strategies Driving Financial Performance
The answer is that just as no strategy works in every situation, neither does one strategy work forever. The goal of the CFO should be to educate the owner to the needs of the other users of the financial statements. Often the benefits of paying higher income taxes is offset by the increased growth rate of the company.