Evelyn

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So far Evelyn has created 264 blog entries.

Not all cash is the same!

By | 2016-04-28T04:14:00+00:00 April 28th, 2016|

Cash is the lifeblood of a business. A business owner gets cash from every day activities (operations), financing or investing. Cash flow from operations should be the most significant source of cash in a business. However, a business striving for growth would often get financing to fund this growth. Let us take a look at the three main sources of cash below:

Cash flow from operations

Cash flow from operations comes from the sale of goods and services in your business. Cash flow from operations is all the money that flows in and out for daily operations. This is the most important source of cash in the cash flow statement. The cash flow from operations should be sufficient to fund the business normal operations with enough left over for further investments or distributions to owners.

Investments in your business

Cash flow from investments includes cash flows from changes in investments and long term assets. Buying long term assets in your business is an investment in your business. Assets have to be created and maintained to grow. Some assets are held for the income producing value and some are held to appreciate. Not all assets are investments. Investments is money put forth to bring back more. In business, you want good investment assets. A good investment is one whose net present value exceeds the required rate of return. Before investing in an asset, you should analyze the return to estimate whether or not you have a good investment.

Cash flow from financing

Investments are often financed through external sources such as lenders or equity investors. A lender lends you money and you pay the money back over a period of time with interest. Unlike personal loans, I am not against business loans, as long as you can borrow money at a lower rate and then invest it for a higher return. Financing activities can also be used to finance the purchase of inventory. Payments for loans usually come from cash from operations. This is because financing activities are usually used to finance investments that result in more cash flow from operations. Cash from operations should be more than sufficient to pay back loans plus the interest.

In summary, cash is the lifeblood of a business. Understanding the sources and timing of cash is vital. This is why preparing cash flow projections is very essential because you want to know where you have short fall in cash. If a short fall is determined then you need to figure out how to fill the gap. You can choose to sell an asset which will be cash inflow from investment or get a loan or use personal funds which will be cash inflow from financing.

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Wealth versus income

By | 2016-04-22T18:55:56+00:00 April 22nd, 2016|

The word wealth is often confused with income. Wealth could be of various forms, there is spiritual wealth, material wealth, time wealth, etc. Wealth simply means an abundance of something you find valuable. Some people would rather have more time to pursue personal interest, others like material wealth, while others do not place a lot of value on material things but rather value spirituality. All of these values are not mutually exclusive and it’s up to the individual to decide what matters to them.

On the other hand income, is an amount of money brought in from your pursuits. Income could come from a job, a business or investments you have made in the past.

This article focuses on the difference between financial wealth and income. It is possible to have income without wealth. And it is also possible to build wealth with your income. However, as entrepreneurs, we sometimes forget that our business can be a great source of wealth and not just income. Growing your business from an income producing machine into an asset takes some thought. You could have a business that brings in a lot of income but is worth little at time of retirement. This means you cannot sell the business and you retire with very little if you have no other source of wealth.

Creating wealth in your business involves building assets. Assets can be tangible or intangible. Intangible assets like creating systems in your business could increase the multiple at which your business sells. Your systems should include the three legged stool every business should have namely, marketing, financing and operating. All systems running together help your business run smoothly and creates an asset which can be sold for a higher return at a later date.

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Financial Leverage

By | 2016-04-21T05:46:17+00:00 April 21st, 2016|

Financial leverage is using borrowed funds to increase revenue producing assets. This is done with the hopes that the increased income will be more than the cost of borrowing. Using debt financing allows a business owner to benefit from financial leverage. If a business borrows money at 4% and reinvests it with a return of 10%, revenue benefit from the 6% spread.

Moreover, interest expense is tax deductible further reducing the cost of borrowing. If a business owner, borrowed money from an investor, dividends paid to the investor is not tax deductible. Also, when you sell equity, you give away a part of your company which is something you don’t have to do with debt borrowing.

Let us take a look at an example:

ABC Co. has the option to bring in new investors or get a bank loan. The principal amount needed is 100,000 dollars. The bank will loan this money at 4%. ABC co. has a tax rate of 25%. The equity investors also require 4% annual dividends. Let us take a look at the effect of debt financing over equity financing:

 

Equity Financing

Debt Financing

Revenue

50,000

50,000

Expenses

(30,000)

(30,000)

EBIT

20,000

20,000

Interest

0

(4,000)

EBT

20,000

16,000

Tax @ 25%

5,000

4,000

Net Income

15,000

12,000

Dividend

4,000

 

Increase in retained earnings

11,000

12,000

 

Debt financing results in less taxes and also an increase in retained earnings. Regardless of using debt or equity financing, ABC will need to pay 4,000 dollars as either dividend or interest. However with equity financing there is no tax benefit of paying out the 4,000 dollars while with debt financing there is a tax savings of 1,000 dollars.

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Is your income sustainable?

By | 2016-04-20T02:28:56+00:00 April 20th, 2016|

Sustainable income can be defined as the level of income that is most likely achievable by the business not just today but also future years. It excludes all temporary hikes in income due to non-repeatable events. A better way to evaluate your business is how much of your income is sustainable. Sustainable income is different from the actual income on the profit and loss statement. It is the income minus all the noise. Separating your sustainable income from non-sustainable income allows you to plan better by seeing the fruits of your repeatable processes. Ultimately, the repeatable processes are what really builds value
in your business.

Creating repeatable processes makes your business less dependent on you which means you can scale your business more quickly. This means you can enjoy more life outside your business and make your business more attractive to a potential buyer.

While this all sounds good, business owners sometimes find themselves so entrenched in their business that creating sustainable income takes back seat. Sometimes all you need is a little tweak to turn non sustainable income to sustainable income. This takes careful thought and planning. Doing the same thing you have always done expecting a different result is the definition of insanity.

In summary, take the effort to separate your sustainable income from non-sustainable income in your financial statements. Keeping track of sustainable income is crucial. If you lack sustainable income, it is time to rethink your business!

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Some ways to evaluate investments

By | 2016-04-19T04:48:31+00:00 April 19th, 2016|

 

Cash payback period

The cash payback period is the time period it takes to recover the cost of the capital investment from the cash flow generated by the investment. The cash payback is the cost of the investment divided by the net annual cash flow.

Net present value

The net present value discounts net cash flow to its present value. This method compares the present value of the cash inflow to the required investment. The net present value is the difference between the capital requirement and present value of cash flows.

Internal rate of return

Unlike the net present value, the internal rate of return finds the interest yield. The internal rate of return is the amount where NPV equals zero. Excel offers a great tool to help compute this number.

Annual rate of return

The annual rate of return is the expected annual cash flow divided by the average investment. The annual rate of return is compared with the required rate of return to see if the investment is acceptable. The required rate of return is based on the businesses cost of capital. The cost of capital is based on the weighted average of borrowed money and capital investments provided by equity owners.

These are just a few metrics with which a business owner can use to measure potential investments. Investing in new project could be quite risky but with taking the time out to analyze the investment, the chances of making bad investments are reduced.

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The best way to save on taxes

By | 2016-02-20T15:47:38+00:00 February 20th, 2016|

010515_1656_Howcantaxpl1.jpgOwning your business is one of the best way to save on taxes. When you are a W-2 earner, you pay taxes on every dollar earned. As a business owner, you only pay taxes on your net profits. Your net profit is the difference between what you bring in and what you spend in building your business. This means you owe taxes on what is left and not all you made.

For a business expense to be deductible, it has to meet these 3 conditions:

  • The expense must be ordinary and necessary for your business or profession
  • The expense must be directly related to your business – this means not a personal expense
  • The expense must be for a reasonable amount – beware of lavish meals and entertainment expenses

How to deduct your business expenses

How you deduct your business expenses depends on what type of business entity you operate. Whether you are a sole proprietor, C Corporation, S Corporation or partnership, you are allowed deductions before arriving at net income.

Sole proprietor

If you are a sole proprietor, your business expenses are deducted on Schedule C. The net profit is transferred to your form 1040. Your business income is also subject to 15.3% Social Security and Medicare taxes. Paying social security and Medicare taxes is not all bad as this is money that comes back to you when you are 65 and older. You also have to pay federal taxes and depending on your state, pay state taxes too.

However, if you have a loss on your business (that is expenses exceed income), you do not have any income to pay taxes on.

C Corporation

If you own a corporation, you file your taxes on form 1120. Your expenses are also deducted on form 1120. Your corporate tax return is taxed separately from your personal tax return.

S Corporation

An S corporation files a separate tax return on form 1120S but unlike a C corporation the income flows through to your personal tax return. However, unlike the sole proprietorship you do not have to pay self-employment taxes on the income that flows through to your personal tax return. An S Corporation deducts expenses on form 1120S.

A partnership

If you are going to into business with a partner and you do not want the hassle of incorporation, then you can form a partnership. Forming a partnership is as easy as forming a sole proprietorship. You will need to file a separate tax return on form 1065. Your expenses are also deducted on form 1065. Your share of partnership net income flows through to your personal tax return. Partners are not employees and do not get W-2s. Rather than a W-2, they should get a schedule K-1.

LLC

As a LLC you can choose to be taxed a corporation, s corporation, sole proprietor or partnership. See above on how to treat your deductions depending on what entity you choose.

Regardless of what form you choose to operate your business, starting your business is one of the best ways to save on taxes because you do not pay taxes on every dollar earned.

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Why does my business profits not equal my cash?

By | 2016-02-10T03:41:14+00:00 February 10th, 2016|Tags: , |

As a business owner, you have probably wondered why your income sometimes says you make more money than you have in the bank. There are many reasons why business profits don’t equal cash and I will be discussing a few of them.

Operations

This is cash received from or used in the business main operations. A well run business main source of cash will be from operations. In running your business, not all sales result in cash collection upfront and not all expenses are paid with cash up front. Also, non-cash expenses like depreciation decrease your income but do not affect your cash flow.

Financing

Businesses often use debt or money from other investors to purchase business assets. Companies can finance operations by issuing stock, borrowing money, etc. These activities are not cash flow from the business operations but receiving them increases your total cash.

In addition, dividends paid to shareholders do not decrease your profitability. Dividends are paid from retained earnings (past income) and does not show up on the income statement as an expense. Dividends paid is a reduction of equity.

Investments

Cash flow from investments is mainly used to ensure that the required assets needed to support efficient operation are acquired and maintained. Investments are made to increase a business’s competitiveness in the market place. When you buy assets, these amounts do not flow to the income statement right away. However, the cash decreases when investments are made.

These are a few reasons why your bank statement gives one number and your income statement gives another. Understanding how these numbers are related is essential to succeeding in business.

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How should a business with free help or who uses personal equipment for business treat the cost in the accounting records?

By | 2016-02-05T16:19:04+00:00 February 5th, 2016|Tags: , |

ID-100288657Before I answer this question, let us examine the main goal of accounting. Accounting should provide useful information to stakeholders. This information should be useful for taking meaningful actions. This means you have to cost out your business as if nothing is received for free. In the long run, it is going to be impossible to run your business unless you can cover “all” costs. Using wrong cost information will also cause you to underprice your services. This sets a precedence for your customers to always expect low prices

Solution – Personal Assets

All personal assets you convert to business assets should be recorded in the books at fair value and depreciated over a reasonable life. This will increase your overhead which is what you want to happen. Your depreciation will show up on your income statement and give a true picture of your profitability. On the other hand, the asset will increase the value of your business.

Solution – Free Service

While the cost of free service provided by your relative (most likely your spouse) should not be added to your books because it is not an actual expense, it should be included in your budget at market rate. This is because someday you may need to pay your wife or hire someone else to get the work done. If you do not, you will have a hard time continuing your business once this free help does not exist. Also, including the market rate of free help in your budget, allows you to be prudent by charging based on your actual cost and not just cash outflow.

Keeping good track of expenses not just cash outflow is essential for long term survival.

Increase your financial IQ [grwebform url=”https://app.getresponse.com/view_webform_v2.js?u=SHTY&webforms_id=2473701″ css=”on” center=”on” center_margin=”200″/]

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

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Bad Accounting, Bad Information, Wrong Action!

By | 2016-02-04T15:49:48+00:00 February 4th, 2016|

Accounting is the language of business. To make good business decisions you need to understand this language. Take for instance the difference between the cost of making your product and the cost to support the existence of your product. Both are vital information but mistaking one for the other could be very costly mistake.

Cost of making your product

The cost of making your product also called your product cost should consist of the cost you absolutely need to make your product available to the market. Due to the nature of the cost, it is often stored as an asset on the balance sheet statement until it is sold. This is an accurate depiction of how the cost behaves. Just like an asset, product cost has future value and should not be expensed right away.

So what happens if you include cost that are not absolutely needed to make your product? For starters, you do not know what it cost you to make your product. Product cost should be examined on its own merit. Knowing what it cost you to make a product, would help you examine if there are better more productive ways to create the same thing. It also helps you determine the profitability of each product on an individual basis. Adding cost that are not essential to making the product distorts this cost.

Cost to support the existence of your product.

On the other end of the spectrum, a business cannot exist with product cost alone. If this was so, there will be no such thing as a broke entrepreneur. Every product needs a support system and this is what we call your period cost. Unlike product cost, period cost is expensed at the time they happen. A good example of a period cost is marketing. We all know that marketing is the life blood of any business. While it is not part of your product cost, your business will not survive very long without it.

Also, note that period costs exist to support the product. This is key because I see a lot of financial statements with cost that have no bearing to any revenue stream. This is why it is very important to fully understand the way the cost in your business behaves. Accounting for cost in the wrong way, would lead to bad information and finally taking the wrong action.

If you want more, get my free e-book categorizing transactions.

Image courtesy of Stuart Miles at FreeDigitalPhotos.net

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Action and reaction

By | 2016-02-03T04:45:16+00:00 February 3rd, 2016|Tags: |

Everything you do has a consequence: For every action there is a reaction. Every ball you throw up will eventually come down. In some cases, the consequences are instant and in other cases, the consequences are delayed. For instance, people often find it easy to overspend because the consequences of debt do not happen overnight. It is the same with overeating. When consequences are delayed, being disciplined takes more will power. If my car was reposed every time I overspent, I will be less likely to overspend and keep to a budget.

Action and reaction also come into play when it comes to being kind to others. We are always so busy and self-absorbed in our world, we often fail to see the pain of others. When was the last time you smiled at someone you walked by and genuinely wished them a nice day? A little smile could go a long way in someone else’s life. Your smile might be the right motivation someone needs to get through the day. With the rise of social media, people feel more and more invisible in the world. Smiling at someone else makes people feel seen.

Everything you do has a reaction. Everything that happens has an effect in the world. The cause and effect of the world is exactly what your financial statements keep track of. When you are kind to people it does eventually pay off.

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Lifestyle CPA

Financial Keepers, LLC
Innovate Springfield
15 South Old State Capitol Plaza,
2nd Floor Springfield, IL 62701
Telephone: 417-812-5945

Phone

417-812-5945