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Pitfalls to Avoid When Growing Your Business

A strong economy drives business growth. I think most of us can agree on that. Growth is usually good…

But if it is not controlled growth, it simply will not be sustainable.

In this blog, I outline several pitfalls to avoid when growing your business (especially in a high growth scenario). It’s all about managing the growth properly.

We have two current clients that are experiencing high growth, and they can barely make payroll.

With a pipeline of huge sales, how can this be possible…?

Their lack of planning on systems and procedures has also caused the management to not sleep well at night.

SCFO Lab Members: The reason most income statement projections fail is because of a lack of ability to accurately project sales! Start the Sales Genie EP now.

What Happens in a High Growth Scenario?

So, what happens in a high growth scenario? It should be all good news… The problem is that many times the decision maker(s) of a high growth company have never experienced high growth. Sometimes, these can be startups or a business that developed a new product.

If you have not experienced it, then it really is hard to imagine all the things that can take place.

Example of a High Growth Scenario

Let’s look at an example of a high growth scenario in a made-up company…

You are a manufacturer of widgets and you own a manufacturing facility. You have 50 employees before the company is about to explode in growth.

Your VP of Business Development or VP of Sales brings you new contracts that will significantly change the size of your company.  These contracts will double, triple, or even quadruple your business in the next 18-24 months.

So no worry about generating sales….

But there are several questions that need to be asked and pitfalls to avoid in this company.

Pitfalls to Avoid When Growing Your Business

Inventory: How are you going to fill all those orders?

You need to purchase a lot of inventory of raw material. In addition, your purchasing transactions just tripled in dollars and quantity. Finally, you have enough machines to manufacture items for the next 12 months… But next year, you will need to acquire more machines to keep up with demand.

Labor: What about labor?

The purchasing person is working already 50 hour weeks, and you know you will need to hire another purchasing person. Your plant labor needs to increase to compensate with the increased workload.

Right now, your 3 person accounting team includes 2 bookkeepers and a controller. You realize you need a cost accountant.

Systems, Process and Procedures

You have used a basic accounting system for 10 years, but you realize that you have outgrown the accounting system. It is not the right system because it does not handle cost accounting or standard costs. You want to integrate purchasing and inventory modules.

For years, you kept inventory and work-in-process on spreadsheets. Now, the dozens of spreadsheets are not reconciling. It’s time to automate inventory.

The once per year physical count of inventory is no longer enough. You need to have cycle counts and maybe at least a full physical count quarterly.

For years, you have operated informally, but you now you realize you need to have written policies and procedures.

Accounting

You have run your business on a hybrid cash/accrual system, never really got to full accrual accounting, and never really worried about GAAP financial statements. Maybe you should…

You never considered having your financial statements audited; however, with all this growth, you might sell one day. Having your financial statements audited would add value to your business.

Your company is growing so much, you need more than financial statements that tell you what happened in the past. Now, you need projections, budgets, and dashboards.

It’s time for a strategic financial partner. It’s time for a CFO.

Click here to access our Goldilocks Sales Method, and learn how to build your sales pipeline and project accurately.

Human Resources

Your admin person that did a great job all these years is now dealing with 3 or 4 times as many employees. It’s time to hire someone that has a good understanding of labor laws.

Payroll was done in house. Now with so many hourly people and manual time sheets, it’s time to upgrade and integrate payroll to the accounting system or have it outsourced.

Consider automated time keeping and get away from the multiple spreadsheets.

Legal and Tax

Your new sales take you out of State. Now, you are selling in 5 different States.

Have you created nexus in these other States? They have State taxes… Oops!

You had to hire a few people on the ground in the other States; your labor laws just got really complicated.

Sales and Use tax… Are you paying the correct taxes, not paying them, or over paying them?

You developed a new process or Intellectual Property (“I.P.”). Did you register this? Did your attorney suggest maybe creating a new legal entity that has the I.P.?

By creating the new legal entity or new legal entities, did you realize you just created a lot of complex accounting work by having all those legal entities?

Note: We recently had a client that created 19 legal entities because their attorney wanted to “protect” them from everything. Now, they had to consolidate all those entities with hundreds of intercompany transactions.

What is your Exit Strategy?

You will be quadrupling the size of your business in the next 2-3 years. You thought to yourself one day… I might want to sell this business.

What does it take to sell your larger company?

It takes time to set a strategy for an exit. It takes time to “professionalize” management and your back office.

Do you have a succession plan so that the business does not look like a one man show?

Do you have a 3-year budget with projections?

SCFO Lab Members: If you want to build your exit strategy and/or access your readiness for market, check out the Exit Strategy EP

How to Have Sustainable High Growth

I have hit on some of the basic topics that come up in a high growth scenario. There are many more things to consider.

The first thing that comes to mind is how are you going to pay for all this?

Do you have sufficient working capital?

Sometimes, you can manage working capital and have sustainable growth.

Many times, you need some sort of financing because of the timing differences in working capital. You cannot afford to sustain this high growth with out the financing.

Cash and working capital are key to the sustainable growth.

But just as important is having the right people. Not just having the right people on the bus… But having them in the right seat on the bus is critical. Not everyone is meant to sit in the same seat in a larger company. This applies to the management team as well as employees.

I have actually seen situations in high growth companies where the person that really needed to be fired was the owner or CEO.  Because the CEO of a $5 million dollar company is not necessarily the same CEO of a $50 million dollar company.

Don’t get me wrong… The ownership does not have to change. You can still own the business. But that does not mean you need to be an employee running the business.

Summary

In order to have sustainable high growth that will allow you to sleep well at night consider the above items but you must have the following…

  • Enough working capital
  • The right people in the right seats “on the bus”
  • More and different systems, process, and procedures
  • A strategic plan that will allow you to have a sustainable bigger company

Projections are a helpful way to grow sustainably and avoid an uncontrollable high growth scenario. Download our free Goldilocks Sales Method to start building your pipeline and projecting accurately.

Pitfalls to Avoid When Growing Your Business

Pitfalls to Avoid When Growing Your Business

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Tax Brackets

See Also:
Marginal Tax Rate
Prepaid Income Tax
Ad Valorem Tax
Deferred Income Tax
Cash Flow After Tax

Tax Brackets

What are tax brackets? Tax brackets are levels of taxation determined by income. Individuals with income falling within a certain tax bracket pay taxes according to the stated rate for that bracket. Typically, lower income is taxed at a lower rate and higher income is taxed at a higher rate. The idea is that people making more money can afford to pay more taxes and still live comfortably while people making less money have less income available to pay towards taxes. Tax brackets are a component of progressive tax rate systems.

Tax Bracket Example on 2008’s Tax Rates

Here is a tax bracket example based on 2008’s tax rates. Let’s look at three individuals with three different incomes. The first person earns annual taxable income of $20,000 dollars. The second earns annual taxable income of $50,000 dollars. The third person earns annual taxable income of $150,000 dollars.

The tax brackets for this hypothetical example are as follows. Individuals making less than $25,000 dollars of annual taxable income must pay taxes at the rate of 15%. Individuals earning income between $25,001 and $50,000 dollars must pay taxes at a rate of 20%. And individuals making more than $50,001 dollars of annual taxable income must pay 25% taxes.

In this example, the first individual, the person with a salary of $20,000 who pays taxes according to the first tax bracket tax rate, pays taxes of 15%. This amounts to $3,000 dollars of taxes due for that individual. The second individual, the person earning $50,000 dollars who is taxed at 20% ends up paying taxes of $10,000. While the third individual, the one making $150,000 dollars and paying taxes at a rate of 25% ends up paying $37,500 dollars. Of course, these are not the real tax brackets in the U.S. or elsewhere, they are merely hypothetical examples for illustrative purposes.

US Tax Brackets 2008

Tax Rate      Single                    Married Filing Jointly 
10%           $0 - $8,025               $0 - $16,050 
15%           $8,026 - $32,550          $16,051 - $65,100 
25%           $32,551 - $78,850         $65,101 - $131,450 
28%           $78,851 - $164,550        $131,451 - $200,300 
33%           $164,551 - $357,700       $200,301 - $357,700 
35%           Over $357,701             Over $357,701

Tax Bracket Example on 2018’s Tax Rates

Let’s look at another tax bracket example based on 2018’s tax rates. There are three different people that earn different incomes. The first person earns annual taxable income of $50,000 dollars. The second earns annual taxable income of $100,000 dollars. The third person earns annual taxable income of $250,000 dollars. By using the US Tax Brackets 2018 chart below, the first person is in the 22% tax bracket; the second person in the 24% tax bracket; the third person in the 35% tax bracket.

The first individual makes $50,000. Using the 22% bracket, this individual owes $11,000.

The second individual makes $100,000. Using the 24% bracket, this individual owes $24,000.

The third individual makes $250,000. Using the 35% bracket, this individual owes $87,500.

US Tax Brackets 2018

Tax Rate      Single                    Married Filing Jointly 
10%           $0 - $9,524               $0 - $19,049 
12%           $9,525 - $38,699          $19,050 - $77,399 
22%           $38,700 - $82,499         $77,400 - $164,999 
24%           $82,500 - $157,499        $165,000 - $314,999 
32%           $157,500 - $199,999       $315,000 - $399,999 
35%           $200,000 - $499,999       $400,000 - $599,999
37%           $500,000 +                $600,000 +

IRS Tax Bracket Information

For IRS tax bracket information, IRS tax bracket tables, and IRS tax brackets for 2018, go to the following website: irs.gov.

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tax brackets

Originally posted by Jim Wilkinson on July 24, 2013. 

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Fiscal vs Monetary Policy

Fiscal vs Monetary Policy

What is Fiscal Policy?

Fiscal policy is essentially how the government decides to collect and spend money to impact the economy. This is studied in Macroeconomics to better understand the relationship between the economy and governmental influence. The study of fiscal policy is useful in speculating the reaction to changes in the government’s budget. It is also a frequent topic during presidential elections, because fiscal policy affects numerous industries.

For businesses, fiscal policy can be very important. Some businesses are directly impacted by government interaction in the economy. For example, businesses that have government agencies as their clients depend upon a fiscal policy that includes their services. Furthermore, other businesses are impacted by fluctuating taxes. Some industries are more exposed than others to taxes. So it is very important that the leadership of businesses takes these macro-elements into consideration.

Expansionary Fiscal Policy

There are three phases of fiscal policy that the government switches between depending on the outlook of the economy. Use the term expansionary fiscal policy when the government is spending more than it is receiving. Generally, this stimulates the economy during a recession or downturn. At the onset of a recession, high government spending with no rise in taxes is common. Then increased taxes and decreased spending follows. If this phase of fiscal policy does not work, it can leave the government in a greater deficit without a recovered economy.

Contractionary Fiscal Policy

Contractionary fiscal policy is the opposite of expansionary. It involves spending less than the government collects in taxes. Rather than attempting to stimulate the economy, this phase restrains the economy. This includes controlling inflation and paying down debt. Another tool of contractionary fiscal policy is raising taxes. When the government raises taxes, households have less disposable income while the government has more to spend.

Neutral fiscal policy is the phase between expansionary and contractionary fiscal policies. This is a period of time when the government’s spending is approximately the same as its collections. This phase is often a transition period between expansionary and contractionary policies, so it is a time of speculation and uncertain governmental policies.

What is Monetary Policy?

Use monetary policy to describe the decisions over a nation’s money supply. In the United States, the Federal Reserve has this duty. The key decisions affecting monetary policy are setting interest rates, setting bank reserve requirements, and buying/selling government securities. Thus, the same agency as fiscal policy does not control the monetary policy.

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Fiscal vs Monetary Policy

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Fiscal vs Monetary Policy

See Also:
Generally Accepted Accounting Principles (GAAP)
Economic Drivers to Watch

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Tax Efficiency

See Also:
Federal Unemployment Tax Act (FUTA)
Tax Brackets
Prepaid Income Tax
Marginal Tax Rate
Cash Flow After Tax
Ad Valorem Tax

Tax Efficiency Definition

Tax efficiency, defined as the process of organizing an investment so that it receives the least possible taxation, is as important in general investment as it is in business. Business, commercial investments, and even private investment vehicles can experience tax efficiency through planning. Any time a person has caused a change which avoids a higher tax rate they are experiencing the benefits of a change in their tax efficiency rating.


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Tax Efficiency Meaning

Tax efficiency means paying less to the government due to some changes in the structure of an investment. This can have relatively minor or an extremely profound effect on net profit depending on the scale of the investment in question.

For public market investments, achieve an increased tax efficiency ratio through a variety of means. Tax free bonds and money market accounts, stocks which are held over one year, and tax efficiency of etfs other than this can be utilized for an income which is greater than their taxed counterpart.

For businesses, tax efficiency can be gained through other means. The structure of the legal entity that is the business can effect tax efficiency: LLC’s do not experience double-taxation like corporations do. Additionally, moving finances from account to account inside the business can also leave less to be taxed. Reinvesting profits into research and development rather than taking company profits is one option: the business experiences less capital gains than if it kept the income.

In personal finances, other investment tools can increase tax efficiency. For example, a Roth IRA has increased tax efficiency over some other tools. For proper planning it is important to consult with a financial planner and find out which tool is best for each circumstance.

Tax accountants are the experts in creating tax efficiency. For those who have a large amount of funds tied up in investments a tax accountant is a necessity. These trained professionals can inform the business owner on the proper structuring of business, investment, and personal finances.

Example

Dom is a business owner who is experiencing new success. His business is taking off like never before and has provided a lot of extra income as it does this. Dom has no need to reinvest this money into the business as it already has enough free cash flow. Dom has decided to diversify his holdings by investing in other places. He now needs to bring it together to increase his tax efficiency of index funds and business dealings alike.

Dom arranges a meeting with both his financial advisor and his tax accountant. He knows these two will not see eye-to-eye on everything but wants to bring his investments to work together.

His meeting goes quite well. Dom has received advice that will benefit him immensely. From his tax accountant, he received advice on restructuring his business entity as well as accounting methods. From his financial advisor, he was informed about places to invest which hold value steady and will increase tax efficiency of mutual funds. Dom leaves with a good attitude that tomorrow will be better than today.

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tax efficiency

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Tax Abatement

Tax Abatement Definition

Tax abatement, defined as the decreasing of the tax responsibility of a firm by government, is one of the tools which government uses to motivate behavior in a firm. A tax abatement credit is generally given to a firm when the government wants the saved money to be spent in another way: to increase savings or spending rate, invest in equipment, or others.

Tax Abatement Meaning

Tax abatement means a tax incentive given to business‘ for the purpose of spending it in another way. These motivations are common to in the business world; tax breaks for research and development, depreciation, and more. These perks allow a business to focus on the future rather than trying to survive in the present.

From a governmental standpoint, a tax abatement program is a tool to motivate business to operate a certain way. Similar to the savings and loan crisis of the 1980’s, where government increased regulations, tax abatements have the opposite effect. Rather than preventing certain behavior, a tax abatement agreement can make other behaviors easier and more appealing. This type of approach is favored by many economists.

Tax Abatement Example

Claus is the owner of a technology company. Creating microprocessors, Claus has many expenses to cover along the path of creating a better product. Claus must constantly be thinking forward to what the market will do.

Claus’ company experiences many tax abatements. First, he has a depreciation schedule for many of his capital expenses. Thanks to the tax abatement forms he completes, he can recover the expense of these items rather than having to pay for them. Claus’ company also receives tax abatement for research and development. Here, his company can recover the expenses of r&d. Due to the fact that r&d takes quite a while to create return on investment, Claus can use the cash he saves rather than having it tied up into finding a better way to do business.

Claus is very thankful for the tax abatement he receives. It makes his life, as well as his business operations, much easier. When Claus goes home he must fill out yet another tax abatement letter; the IRS discount for having a family with children.

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tax abatement

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tax abatement

See Also:
Direct Tax
Tax Brackets
Ad Valorem Tax
Tax Efficiency
Federal Unemployment Tax Act (FUTA)

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Prepaid Income Tax

In accounting, Prepaid Income Tax is defined as an asset listed on the balance sheet that represents taxes that have been already paid despite not yet having been incurred. It is also called a deferred income tax asset.

Prepaid Income Tax Explanation

Prepaid income tax is a form of prepaid expense. The most common reason why prepayment on income taxes occurs is due to over-estimation of tax deposits. In this situation, taxes are estimated from the financial records of the previous year. These estimated taxes are paid. Then, when the year-end taxes are found to be less than the taxes paid earlier, prepayment on income taxes has occurred. This prepayment can create one of two results. Either it results in a tax refund or the credit written off towards the tax liability of the next period.

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The difference between prepaid income tax and a deferred tax asset is that prepaid income tax occurs within one year. Conversely, a deferred income tax asset can occur for a period of longer than one year.

Often, prepaid income taxes are the result of poor assumptions. Generally, company controllers overestimate the needed tax deposits. In conclusion, this is one of the most common cases leading to prepaid income taxes.

Prepaid Income Tax Journal Entry

The following is what the prepaid income tax journal entry may look like:

DR                                                    CR
Prepaid Income Tax               $100,000
Cash                                                                                              $100,000

Income Tax Expense              $25,000
Prepaid Income Tax                                                                   $25,000

Result: Prepaid income tax balance = $75,000

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Prepaid Income Tax

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Prepaid Income Tax

See Also:

Marginal Tax Rate
Tax Brackets
Flat Tax Rates
Cash Flow After Tax
Unclaimed Property

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Modified Accelerated Cost Recovery System (MACRS)

See Also:
Straight Line Depreciation
Double Declining Depreciation Method
Accelerated Method of Depreciation
Financial Accounting Standards Board (FASB)
Generally Accepted Accounting Principles

Modified Accelerated Cost Recovery System Definition

The modified accelerated cost recovery system (MACRS) method of depreciation assigns specific types of assets to categories with distinct accelerated depreciation schedules. Furthermore, MACRS is required by the IRS for tax reporting but is not approved by GAAP for external reporting.

MACRS Depreciation Calculation

To calculate depreciation for an asset using MACRS, first determine the asset’s classification. Then use the table (below) to find the appropriate depreciation schedule.

When using MACRS, an asset does not have any salvage value. This is because the asset is always depreciated down to zero as the sum of the depreciation rates for each category always adds up to 100%. When calculating depreciation expense for MACRS, always use the original purchase price of the asset as the depreciable base for each period. Note that you depreciate each category for one year longer than its classification period. For example, depreciate an asset classified under 3-Year MACRS for 4 years. Then depreciate an asset classified under 5-Year MACRS for 6 years, and so on.

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MACRS Example

For example, an asset purchased for $100,000 that falls into the 3-Year MACRS category shown below, would be depreciated as follows:

YearDepreciation Rate     Depreciation Expense
  1     33.33%         $33,330     (33.33% x $100,000)
  2     44.45%         $44,450     (44.45% x $100,000)
  3     14.81%         $14,810     (14.81% x $100,000)
  4      7.41%          $7,410     (7.41%   x $100,000)

MACRS Depreciation Table

Below is the table for Half-Year Convention MACRS for 3, 5, 7, 10, 15, and 20 year depreciation schedules.

Depreciation Rates (%)

Year    3-Year    5-Year   7-Year   10-Year  15-Year  20-Year 

  1     33.33     20       14.29    10       5        3.75
  2     44.45     32       24.49    18       9.5      7.219
  3     14.81     19.2     17.49    14.4     8.55     6.677
  4      7.41     11.52    12.49    11.52    7.7      6.177
  5               11.52     8.93     9.22    6.93     5.713
  6                5.76     8.92     7.37    6.23     5.285
  7                         8.93     6.55    5.9      4.888
  8                         4.46     6.55    5.9      4.522
  9                                  6.56    5.91     4.462
 10                                  6.55    5.9      4.461
 11                                  3.28    5.91     4.462
 12                                          5.9      4.461
 13                                          5.91     4.462
 14                                          5.9      4.461
 15                                          5.91     4.462
 16                                          2.95     4.461
 17                                                   4.462
 18                                                   4.461
 19                                                   4.462
 20                                                   4.461
 21                                                   2.231

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Modified Accelerated Cost Recovery System

Modified Accelerated Cost Recovery System

MACRS and the IRS

For more detailed information regarding MACRS, go to: irs.gov/publications

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