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Why Start-ups Should NOT focus on Cash Flows

 

The first thing I usually hear when a new client comes on board, especially a new client in the start-up phase, is “I want to work on my cash flow statement”. And while I am happy to help create one, there is an inherent road block in a start-up focusing on cash flow – you have no idea where your sales are coming from!

For some reason cash flow seems to be the creditor favourite for lending. In lieu of historical financial statements for start-ups, they’ll often ask for cash flow projections and future sales growth etc. before approving any lending applications. And then you are held accountable to meet those projections because that was the basis of the loan.

A cash flow projection is supposed to help you manage when money is coming in and when money is going out; but this assumes that you have a consistent stream of money in/out to be able to make this work! If you’re a start-up then you don’t have a steady sales stream yet. Not to mention, you’re probably still experimenting with your costs so you’re expenses are fluctuating as you play around with things. This means you can project a sales of $10,000 and expenses of $8000 for September… but you don’t have enough historical data to really see if this is a reasonable projection. And now you’re being held accountable to something that maybe should not have been set in the first place.

Instead, a break-even analysis is a much more useful tool for entrepreneurs to use in the start-up phase. What this analysis shows is how much sales you would need to just cover your fixed costs. This, for most entrepreneurs, is the goal in the beginning – just to break even and maybe show a little profit. To calculate this you take your average sales price divided by your fixed costs. This will give you the number of sales you need to cover your costs.

This, for a start-up, provides a more reasonable goal to work towards. Once you’re consistently covering your costs you can start focusing on bigger sales targets. When you have consistent monthly revenues and expenses, then a cash flow projection can be made!

 

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

 

ANXIETY IN NUMBERS

Many entrepreneurs don’t take the time to understand their numbers, in fact, most ignore them altogether!! They rely on their bank balance to tell them if they’re doing well or not and just get the bookkeeping done for the sake of taxes.  That may work for you, but how are you going to make informed decisions if you live in obliviousness of your numbers? They tell you the story of how your business is doing and can give you great insights into what’s working, and most importantly, what’s not!

Here are some of the top Key Performance Indicators (KPI’s) you should monitor for your business.

  1. Advertising as a Return on Investment (ROI)

We know advertising is necessary for business growth, brand development and awareness, and most importantly sales. But not all advertising channels work the same. In the beginning you may advertising anywhere that will have showcase you, but the key is to track which of these channels actually brings you clients. Try using a different promo code in each channel so that you can track which is working and get rid of the ones that aren’t.

  1. Inventory turnover

If you have a product based company where you buy the inventory upfront to try and resell it, then this KPI is vital for you. Inventory turnover is the number of times inventory is sold over a time period, which can be monthly, quarterly or annually. This will help you track what inventory is moving and what takes longer to sell. Accordingly you can adjust your buying choices and often your marketing choices too.

  1. Accounts Receivable turnover

This one is really important if you have repeat customers. These days many businesses operate on a “pay before you receive” model wherein the customer is paying for the product or service before it is delivered. However, many businesses still have the more traditional model of providing a service and then invoicing for the work completed, thus resulting in a period of time where you are waiting for a customer to pay. By keeping track of AR turnover you can identify whether your companies policy for credit is working as intended or whether you wish to continue to do services for clients who are perpetually late. A good accounting system will also allow you to review an AR aging to see which customer is always past due.

  1. Gross Margin

Again if you are in an inventory based business, you need to be aware of two factors: first you need to factor in the cost of inventory into all your sales and second you need to make sure you have enough of a markup to not only cover your inventory cost but your operating cost. Doing a gross margin analysis combined with a break even analysis will help you figure out if your pricing structure is working for you or not.

  1. Budget to actual

You’d be surprised how many entrepreneurs don’t have a budget, or if they do, they don’t compare their budget to actual numbers. A budget is not set in stone, of course, but knowing how your actual sales/expenses compared to what you were forecasting can tell you a lot about your business initiatives.

Of course the key to doing any of the above is timely and accurate bookkeeping and financial reporting!

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

The Cash Flow Paradox

 

The number one concern most business owners have – especially in the beginning – is how to manage their cash flows. It’s not just about generating the sales – but getting those clients to pay. Pay on time. So you can pay your bills on time. And just because you aren’t getting paid doesn’t mean that your vendors will excuse your late payment. And so we find ourselves in this cash flow paradox of you need money to pay your bills, but what do you do when your clients just aren’t paying you?

The reality is cash flow ups and downs happen in any business and the excuse of your clients aren’t paying you does not bode well with most vendors. You need to be prepared for this and have a plan. The solution is a business line of credit.

For some reason most entrepreneurs do not want to get a business line of credit. Perhaps they’re afraid they’ll abuse the credit available or they need to personally guarantee it. But the fact of the matter is, you will inevitably need it at some point. Here are the two mistakes I see the most when it comes to borrowing money.

  1. Timing

Getting a line of credit can be a challenge for many business owners. If you’re a new business you don’t have enough credit established as a business and many banks will deny you unless you personally guarantee the loan. If you’re an established business, but have a lot of debts, you can also be denied the loan. Or If you’re an established business, the banks can question why you need a bank loan now when you’ve been in business for X years already. It can be a red flag to all of a sudden need to borrow money unless you have an expansion or specific tangible purpose.

Typically banks and creditors like to support clients in either the start-up phase or the expanding phase. So getting a line of credit established early on – even if you have to personally guarantee or put up some collateral – is advisable. You can support your business case by citing all the start-up costs that require immediate cash flow (website, advertising, space rental etc) and banks understand that in the beginning there will be more money out than in. Versus, needing money to just survive. The latter is a guaranteed loan denial. So ask for the line of credit application when you’re starting your business!  You don’t have to use it, but it’s easier to not use it when you have it, than be denied when you need it.

  1. Borrowing the wrong way.

Yes, there is a right and wrong way to borrow. The right way includes a nice tax write off! If you borrow money for business purposes, the interest you pay on that loan is TAX DEDUCTIBLE. Yay!

Often what I see happen is entrepreneurs put their SAVINGS in the business and then BORROW to fund their PERSONAL lives. Borrowing for personal purposes is NOT tax deductible. So only use your personal savings into the business if you have enough to cover your personal needs. Otherwise, see point 1 about getting a line of credit.

Note: even if you use your personal line of credit for business purposes the interest is still tax deductible. Either way, you need to be able to support the “business purpose” with a paper trail.

 

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

Business Use of Home Expenses

Note: This information differs slightly for employees who are required/allowed to work from home.

Many entrepreneurs love the idea of starting a business from home because now they get to claim the home expenses – or rather a portion of them – as a business expense! BUT entrepreneurs beware there are conditions to be met!

You need to meet ONE of the following conditions:

  1. It needs to be you principal place of business OR
  2. You use the space only to earn business income AND you use it regularly and on an ongoing basis to meet your customers, clients or patients.

So what does that mean?

If you always meet clients at a coffee shop, restaurants or their place of business, and never in your home, it can be a challenge to justify why you need to claim a home office.  Furthermore, if you are also expensing a secondary office space (meeting rooms, rented office spaces) justifying the need for a home office becomes even harder. Needing a place to keep your computer and files often is not strong enough.  However taking calls, doing client work, and using that room for other functions relating to contracting business can be a better justification. Note there is also an implied expectation of a separate room or dedicated work area; using the kitchen table does not cut it.

Once you have determined that your home office you can claim a percent of the following expenses:

  • Heat
  • Electricity
  • Insurance
  • Maintenance
  • Mortgage INTEREST
  • Property taxes
  • Other expenses (such as water)

It is important to also mention that the amount you deduct cannot be more than your net income; so the expenses relating to the home office cannot create a business loss. So we recommend calculating your net income (Revenue less expenses) for everything else first, then seeing if home expenses make the cut. These expenses can be carried forward with certain conditions.

When you sell your house, there will be what’s called a recapture if you have deducted depreciation on the value of the house so our recommendations is not to do any depreciation relating to your house!

 

 

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

The Cost of Hiring an Amateur

Understandably as a business owner there are A LOT of expenses to start and run your business. A common area entrepreneurs try to save a little is by doing their own bookkeeping. However bookkeeping is a vital process for a business and doing this wrong can be financially devastating! If you are going to be a DIYselfer avoid the following mistakes!

  • Keep track of your personal contributions into the business! The money you invest becomes part of your cost base and one day you will need to know what this cost when you sell the business or die. Keeping track of your personal contributions into the business will also have an immediate tax impact when you want to withdraw money from the business.
  • Missing eligible deductions! You don’t know what you don’t know and that could result in you missing eligible deductions or not maximizing the expenses you are claiming. So what? That means more taxes paid (or not enough loss recorded!). This is a hard one to learn on your own and some accountants or business development centers do offer courses on exactly this.
  • Not preparing financial statements! If you are just using an excel spreadsheet and putting your expenses under the right column heading; unfortunately this is not going to be helpful. Yes you have a grand total at the end of the month, and you can use this to make an income statement, but what you are lacking is the ability to make a balance sheet. This will be of greater consequence if you ever need to ask for a bank loan, investors or want to sell the business – they will want to see a complete set of financial statements.
  • Mixing personal and business finances. If you don’t separate the activities of the business from your personal activities it will be virtually impossible for you to truly understand how your business is doing. Did you spend that money investing back into the business… or did you spend it on personal activities? Plus if everything is combined the CRA then will access everything if they are auditing you. Treat the business – mentally and physically – as a separate entity and keep a proper paper trail of activities between business You and personal You.

These mistakes are by no means the full list of common mistakes. But each of these has a significant tax impact and business impact for you often immediately and in the future.

 

 

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

Employee vs. Contractor

In most cases you hire someone to work for you and you put them on payroll. You pay their taxes, CPP, EI and it is a fairly straight forward process. But what if someone comes to you only part of the time, or they are hired for a specific purpose only, how do you handle those individuals?  Many of these part-timers or “occasional” workers are being treated as contractors which means they are not going on your payroll, you are not deducting CPP/EI/Income Taxes. Instead, they are invoicing you for their time, maybe even charging you HST (which you get to claim back!), and you treat them like an operating expense vs. salaries and payroll.

So what is the big deal? In the eyes of the CRA it is a huge deal. They lose out on CPP & EI contributions and receive less income taxes too!

So how can employers help make the right choices? Ask the following questions:

  • How much control does this individual have on their own activities? If you’re dictating what they have to do (i.e. giving them tasks and deliverables and reviewing their work)
  • Do you provide the tools and equipment (computer, phone, equipment)
  • Can that individual subcontract the work or hire their own assistants?
  • How much financial risk is the person taking?
  • How responsible is the worker for their deliverables?
  • Is there an opportunity for the worker to profit?
  • Other factors such as the written contract

All of these individually and combined, as well as the stated intention, is considered in the choice of employee vs contractor.

Let’s take a look at an example:

I need help with my marketing. Person X is great for the job.

Employee à Person X is going to work from my office 2 days a week from 9-3, on my computer, I am purchasing the marketing software, there is no fixed amount of work but they will be told on an on-going basis what we need (e.g. I am telling Person X to write me 5 blogs, 2 Facebook posts with content relating to ABC), I am reviewing that content. Person X is more likely than not an employee and I should put Person X on my payroll.

Contractor à If Person X can choose to work from home OR my office until the work is done, have their own laptop and software, and I am paying them for a package of 5 blogs and 2 Facebook posts, and I approve the final content. Person X could be considered a contractor.

Each scenario needs to be evaluated accordingly. If you are unsure take a look at how similar positions are being treated.

 

 

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

Common Mistakes Made by Small Businesses

You have this fabulous idea to start a business, and you go for it…yea! But then the reality sinks in that running a business is so much more than just selling your product and service. There’s HR and Marketing and IT and ugh worst of them all….accounting!

As an accountant I see small business owners making a few critical mistakes all the time. And the result is they either pay too much in taxes, do not have money to pay themselves, or worst of all go out of business.  Unfortunately accounting is as important to a small business as any other aspect of running a business; and it has a direct financial impact to your business! Here are some the top mistakes made by small business owners:

Not having a budget

You obviously do not start a business thinking it will fail, but in the beginning there WILL be more expenses than income. Until your brand and client list grows your budget is extremely important to sustain you. There will be tough calls to make but without a clear budget, you won’t know how to spread out your expenses.

Not keeping up-to-date records

A budget is fine as a guide but how do you know if you are sticking to it if you only do your bookkeeping once a year for tax time? At a minimum doing your bookkeeping quarterly (monthly is ideal) allows you to track progress and adjust your path accordingly. By doing your bookkeeping ONLY at tax time means it is often too late to make any informed decisions and corrective action.

If they walk, talk and look like an employee…they are an employee

Employee vs contractor is a huge area of audit with the CRA. Many employers will classify workers as contractors to avoid paying into CPP & EI when in reality they are employees and subject to payroll deductions. There are a few factors to consider when making this difference but a big red flag is control – who controls their work and schedule? A legitimate contractor likely will not be reporting to someone else who is controlling and reviewing their work.

Not recording all the personal contributions (properly)

If you ask most entrepreneurs how much money have they put into their business the answer is usually “a lot”…but when you ask them how much they cannot quantify it. This can have significant tax impacts when both taking money out of the business to pay yourself and when you are looking to sell the business.

 

 

 

“Behind Every Great Business is a Great Accountant”

For more information on how to keep your business tax efficient, or to get a consultation on whether you are making all the right tax choices for your business, contact Dharna CPA. www.dharnacpa.ca. Info@dharnacpa.ca

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