Month: December 2023

As tax season approaches, many business owners face a frightening scenario: owing more taxes than they have in cash. It’s a daunting thought, but don’t panic. Here’s how you can see it coming and, more importantly, avoid it.

What Is “Taxable Profit” for a Small Business?

Small businesses are taxed on their “Cash Basis Profits.” In theory, this is to your benefit because it means that your taxable profit should equal the actual cash left over after you pay all your business expenses. 

But the theory won’t protect you if you aren’t careful. Five dangers will misalign your cash on hand and your taxable profit.  Doing any of these things might make paying taxes more painful — now or in the future.

1. Loans: If you borrowed money during the tax year, ensure the loan is not treated as taxable income.  Don’t pay tax on money you did not earn!  Likewise, don’t mistake a loan for cash you can take home.  Loans should be used in the company to produce more profits.  Taking out a loan so you can pay yourself is a slippery slope!
2. Equity: If you put additional personal cash into the company, sold stock, or converted a loan to equity, ensure it is not categorized as income. Equity contributions are not earned and are not taxable.
3. Loan Payments: Paying back a loan is never considered a tax-deductible expense and will not reduce the tax you owe. So if you have profits, and owe taxes, be careful that your loan payments do not overwhelm you and prevent you from having cash on hand at tax time! Too much debt will eventually catch up with you and overwhelm your ability to keep enough cash on hand for taxes and other things.
4. Owner Draws: Also called “distributions”, payments made to the owner (or expenses paid on behalf of the owner) are not tax deductible.  So taking draws will leave you with a higher tax burden and a lower cash balance to pay the tax.  Watch out that Owner Draws don’t drain the company’s ability to make tax payments.
5. Timing: Excess cash is not always associated with strong profits.  Sometimes having cash means you’re doing a better job managing cash flow. Be careful not to drain the bank in a good cash year and then run into a big tax bill the next year.

How to Avoid a Cash Crunch

All of the above items can put your cash balance out of synch with the taxes due.  To avoid getting stuck with too little cash at tax time, try these tips:

• Always Save for Taxes: Regularly set aside a portion of your earnings in a separate account for tax purposes.
• Make Estimated Payments: The IRS loves to hear from you quarterly and may even penalize you for not paying income taxes quarterly. Generally, the non-payment penalty is small, but it is not zero. Quarterly estimated taxes are due on the 15th of January, April, July, and October. 
• Or…Keep Estimated Taxes On Hand: If your business is variable (and you can afford the non-payment penalties), consider keeping the estimated taxes on hand. . Business is unpredictable, and profits early in the year might be offset by losses later on.  If you’ve sent the cash to the IRS, you may have paid tax on profits that never materialize and you won’t get your cash back until the next spring.  
• Consider the Long Term: Save extra for taxes in bad years in anticipation of more profitable years when cash may be tight. It’s true that strong growth typically leads to poor cash flow, so having a tax fund tucked away can save the day!
• Engage in Proactive Tax Planning: Regularly consult with a tax preparer or CPA and explore tax-saving strategies. (We will happily refer you to a good tax preparer.) 
• Stay Informed: Keep accurate books to estimate taxes and manage cash flow effectively. Professional services from companies like FuseCFO can be invaluable in this regard.

Understanding and planning for your tax liabilities as a small business owner is vital to avoid the surprise of a large tax bill without the cash to cover it. Proactive planning and consultation with tax professionals can significantly ease this burden. Schedule your free business analysis with us today. 

Too much cash in your business can be a waste; not enough can be downright dangerous. Striking the right balance is key, but it’s a delicate dance that requires careful consideration and strategic planning.

Rule of Thumb: The 2-Month Benchmark

A good rule of thumb is to keep the equivalent of two months’ worth of all expenses. This includes payroll, cost of goods sold (COGS), overhead, and debt payments. Why? Because running out of cash isn’t just inconvenient; it can be disastrous. To safeguard against this, having a credit card and arranging a line of credit is wise before you find yourself in a pinch.

The Rationale Behind Having Two Months of Cash Reserves

We used to joke about “business just stopping one day,” but the pandemic made that a reality. Keeping two months’ cash on hand can help weather such unforeseen events. Other potential disasters might include customers who default on payments, a bad batch of products leading to returns or discounts, or a PR mishap that slows down your sales (be careful what you say on TikTok!). 

Why Not Keep More?

While having enough cash is crucial, holding onto too much can lead to problems. Employees might become careless with spending, and you may stop watching your money closely; this can lead to errors or even fraud. Additionally, excess cash can negatively impact your company’s valuation, particularly if you’re looking to sell. A buyer may see how much cash you have in the bank and (mistakenly) assume that is how much cash your business actually needs to stay healthy.  The more cash is needed to run the business (called “working capital”) the less a buyer is willing to pay you! 

Having too much cash simply does not add value. Cash sitting in the bank isn’t working for you. (Investing in growth would be an exception to this. To learn more about that, read our previously published article on Return on Invested Capital or ROIC.) Either take your excess capital home or invest it. 

If you have a little extra, consider putting it in a CD or other safe investment, especially now when rates are over 5%. For those with more cash, consider distributing it to owners, investing in bonds, or getting creative by investing in your customers’ or vendors’ companies. 

At Fuse, we’ve made over five private investments. We have invested extra cash into our customers, our vendors, and even a general “Angel Investment Fund.” Frankly, the results have been outstanding. We have better relationships with customers, better alignment with partners, and happier employees fully committed to their clients. 

Advanced Tips for Cash Management

Want to increase your cash on hand?  There are several tricks to keeping as much of it as possible. Here are a few tips:

• Maintain a 13-Week Cash Forecast: Keep an eye on your future balance.
• Measure Your Cash Cycle: Work to reduce the cycle days and free up more cash.
• Evaluate ROIC (Return on Invested Capital): Decide where the best use of your cash is.
• Always Have a Growth Plan: Even if it’s not actionable today, having a plan ensures you’re ready to maximize future investments.

Maximize Your Business’s Potential 

No matter how much cash you keep in the company, Fuse can help you navigate your business’s financial journey. Our free, no-obligation business analysis focuses on enhancing your growth and profitability. We’ll assess your financial health, explore cash flow strategies, and ensure your accounting is on point.

Ready to unlock new opportunities for your business? Schedule your free analysis now.