Entrepreneurship and Small Business Management CASH FLOW AND TAXES This Photo by Unknown Author is licensed under CC BY-SA

Learning Objectives Understand the importance of cash flow management. Know the difference between cash and profits. Read a cash flow statement. Create a cash budget. File appropriate business tax returns for your business.

Cash Flow Is Critical Cash flow refers to money coming in and going out of your business. Without cash on hand, your business will not be able to pay crucial bills. Goal: Never have a negative cash balance.

Tracking Cash Flow Income statement is poor gauge of cash flow. Showing a profit does not mean adequate cash is on hand, due to lag time between… making sales and receiving customer payments. paying for labor/materials and receiving finished goods. Noncash expenses, such as depreciation, can distort the picture. Cash flow statement shows inflows and outflows of money as they occur.

Rules to Keep Cash Flowing Collect cash as soon as possible. Pay your bills by the due date, not earlier. Check your available cash every day. Lease or finance instead of buying equipment, where practical. Avoid buying inventory that you do not need.

Keep an Eye on Working Capital Working capital equals: Current assets minus current liabilities. Amount of cash that would remain if all short-term debt was paid with the cash on hand. If a firm runs out of working capital, it: Will not be able to spend the cash needed to bring a new product to market. Will still have ongoing bills to pay. May not be able to stay in business.

Cash Flow Cycle

Cycles That Affect Cash Flow Transaction cycles—based on operations. A manufacturer may have to pay its suppliers and employees before getting paid by customers. A residential cleaning firm may collect customer payments on the same day as service is provided. Seasonal cycles—based on time of year. A flower store may have more cash around holidays but less at other times. A college bookstore has more cash after school starts but less when it has to buy the inventory.

The Cash Flow Statement Sections of statement: “Inflows” (cash receipts). “Outflows” (cash disbursements). Net change in cash flow. Categories of inflows and outflows: Operations. Investment. Financing.

Sample Cash Flow Statement

Sample Cash Flow Statement (continued)

Steps to Forecast Cash Flow Project cash receipts from all possible sources. Includes cleared checks, credit card payments, and cash itself (no orders). Note assumptions made when estimating. Subtract expenses that must be paid during the forecast time period.

Managing Inventory to Manage Cash Inventory creates risk because it might not be sold at a profit. Sell inventory at a price that covers COGS, storage costs, and pilferage (theft), and still earn a profit. Keep timely and accurate inventory records. Control stock levels to minimize amount of cash tied up in inventory, and prevent waste.

Managing Receivables to Manage Cash Bill and collect monies owed to your business, in a timely manner. Use Aging Schedule to track Accounts Receivable and estimate cash flow. Consider factoring—receivables financing.

Managing Accounts Payable to Manage Cash Use credit (the ability to borrow money) wisely. Negotiate favorable payment terms when opportunities arise. Track payables with an Aging Schedule.

Capital Budgeting and Cash Flow Capital assets affect cash outflows when purchased and cash inflows when liquidated. Use capital budgeting to understand the cash flow required for investments and the expected impact on operating cash flows. Calculate depreciation associated with capital investment to anticipate the tax effects. Plan and analyze each potential capital project separately to determine feasibility.

Burn Rate Pace at which your company will need to spend capital to cover overhead costs before generating a positive cash flow. Number of Months Before Cash Runs Out = (Cash Available + Revenue) Negative Cash Outflow per Month

The Time Value of Money Future value—amount it will accrue (gain) over time through investment. Present value—amount an investment is worth discounted back to the present. Reasons to have your money “now”: Inflation Risk Opportunity

Future Value of a Dollar

Present Value of a Dollar

Self-Employment Tax is: A federal tax that business owners pay on the wages paid to themselves. The Social Security tax obligation for those who are self-employed. The combined equivalent of the employee and employer taxes paid for employees. Paid quarterly, so cash should be put aside for making payments on the due dates.

Income and Sales Taxes Entrepreneurs pay income tax to federal and state governments. Businesses are also subject to local taxes. Tax returns must be filed (mailed or submitted online) by specific dates each year. In most states, if you sell products or services to the public, you must collect sales tax and submit it quarterly.

Tax Issues Vary By Legal Structure Sole proprietorship—all profits reported as personal income by owner. Partnership—profits and losses are shared by partners and reported on their individual tax returns. Limited partnership—similar to a partnership except losses can be used as a tax shelter without exposure to personal liability.

Tax Issues Vary By Legal Structure (continued) C corporation—has “double” taxation: Profits are taxed whether or not a share of the profits is distributed to the owners. Owners also pay personal income tax on any profit distribution they receive. S corporation—profit is taxed only once, as owner income on personal tax returns. Limited liability company (LLC)—separates the owner/partners from personal liability.

How to Avoid Tax Problems Keep accurate financial records throughout the year. Store all ledgers, receipts, and invoices in an organized manner. Hire a tax accountant or attorney as a consultant. If you prepare your own tax returns: Purchase tax software. Ask a tax professional to review your paperwork.