By: Michael Gallagher
Deputy District Director
North Dakota District Office
In a Small Business Research Summary completed for SBA’s Office of Advocacy in September 2011 and titled, Measuring and Modeling the Federal Income Tax Compliance Burden of Small Businesses, it reports that small businesses spend more than 5.5 billion hours fulfilling their income tax obligations. With the April 15th income tax filing deadline still fresh in your mind, you can probably remember all too well how much time you had to spend gathering your information and tracking your financial information during the course of the year.
Your taxes are complete. You have spent your hard earned dollars and time assembling the paper work and completing the forms. What are you doing with the information? Do you stick it in a file drawer and hope that you do not have to pull it out in response to an audit a few years into the future or do you use the information it contains to increase the efficiency and profitability of your business?
Now is the time to take the valuable information you were given by your accountant and place it side by side with last year’s information. Compare how well you have done or address areas that need improvement. The effectiveness of your business management is not always found on the bottom line. If this is your first year in business, you may wish to see if there is good industry information to use in your comparison. This can often be found from trade associations, lenders or perhaps even from your CPA. You can also visit with one of the SBA’s resource partners, SCORE or the Small Business Development Center (SBDC).
Tax information always offers a very basic income statement (profit and loss statement); Schedule C for Sole Proprietors, Form 1065 for Partnerships and Form 1120 for Corporations. From these forms you can look at basic information on sales and expense patterns. Did your sales go up in 2012 over 2011? Be a little careful, during inflationary times with rising prices you may see an increase in sales without an actual increase in product/services sold.
How about expenses? What were your largest expenses? These are the areas where you want to spend additional time to review. Management of the larger costs will have a more direct impact on your bottom line. If you sell a product you will want to look at your Cost of Goods Sold (line 4 on the Schedule C). Now you want to do a little work. Percentages are a far better indicator of the relative change in your business than the whole number.
Let’s say your sales were $200,000 in 2012 and your Cost of Goods (CGS) sold was $60,000, you would have a 30% CGS. If your sales in 2011 were $180,000 and your Cost of Goods Sold was $52,200 you would have a 29% Cost of Goods Sold. You lost a 1% margin or about $2,000 which would eventually be found, or rather not found, on your bottom line. You should ask yourself the question - why? Did prices from your wholesaler go up more than what you could pass on to your customers through increased prices of your product or service? Was there waste or theft? You have to review individual cost items or changes could be lost in the summary. In this situation you could very well have made more profit than the previous year because you reduced interest costs (paid down some debt) or cut back on staff by working more hours yourself, yet you lost part of this benefit because it cost you $2,000 for product.
All expenses should be dealt with in the same way. If your accounting software program does not compute percentages for you or if your accountant does not offer financial statements that show each cost as a percentage of sales (which they really should) then it’s time to get out the spread sheet and put 2011 and 2012 numbers side by side with percentages computed.
Sole proprietorships and small partnerships (those with receipts of less than $250,000 and assets less than $1 million) do not have to prepare a balance sheet for tax purposes, but one should be developed. A balance sheet will help you to determine how your assets are performing. It will also help you to determine the relationship to debt (borrowed money) and equity (your ownership) in the business. You will want to perform a couple of quick calculations for both 2011 and 2012. Compute debt/equity. If your debt was $100,000 last year and your equity was $30,000 your debt/equity ratio was $100,000/$30,000 or 3 to 1. If you find that last year that you had $120,000 debt (hey, you paid some loans off this year) and you had $60,000 in equity at the end of last year your debt/equity ratio last year was 2 to 1. The increase in this ratio from 2 to 1 to 3 to1 shows a greater dependency on debt to operate your business. This is generally not a positive sign. Ask yourself - why did equity decrease? Did you draw more from the business than you found in profits? Did you show a loss?
You’ve spent a lot of time and money in preparing financial information to satisfy federal government requirements. Why not use this information to increase your profitability and the stability of your business? You can get more information or assistance in how to use this information effectively by participating in on-line training. SCORE has some great topics on their web site at http://www.score.org/onlineworkshops/tab-a.
You’ve met with your tax professional, perhaps it is time to visit with a mentor or professional who can help you analyze the results and manage the future. SCORE and the Small Business Development Center (SBDC) can help you in this area. Visit the SBDC website at www.ndsbdc.org for an office near you or find a SCORE Mentor at www.score.org.
Mike Gallagher has been a Business Development Specialist for the U.S. Small Business Administration since 1984, and the Deputy District Director since 2005. A graduate of the University of North Dakota, Mike is a Certified Public Accountant and a former business owner and educator. He can be reached at firstname.lastname@example.org.