entrepreneurship and small business management chapter 14 cash flow and taxes

Entrepreneurship and Small Business Management

Chapter 14 Cash Flow and Taxes

© 2012 Pearson Education, Upper Saddle River, NJ 07458.

All Rights Reserved.2

Entrepreneurship and Small Business Management, 1/eBy Steve Mariotti and Caroline Glackin

Ch. 14 Performance 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




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 StatementCash Flow for Tom’s Custom Blinds, Month of June 2011

Cash Inflows—Operations:

Sales (net of returns) $65,400

Total cash inflows $65,400

Cash Outflows—Operations:

Variable costs:

COGS $29,360

Other (commissions) $6,540

Fixed costs:

Factory rent & utilities $8,000

Sales and administrative

$12,000

Taxes $2,875

Total cash used in operations

$58,775

Net Cash Flow from Operations

$6,625 ($65,400 – $58,775)




Sample Cash Flow Statement (cont.)

Cash Flow for Tom’s Custom Blinds, Month of June 2011

Cash Outflows—Investing:

Purchase of Building $0

Purchase of Equipment $7,000

Net Cash Flow from Investing

$7,000

Cash Inflows—Financing

Loans $20,000

Gifts $300

Equity Investment $0

Net Cash Flow from Financing

$20,300

Net Increase/(Decrease) in Cash

$20,675

($6,625 – $7,000 + $20,300)

Cash, Beginning: $500

Cash, Ending: $21,175

(500 + $20,675)




Steps to Forecast Cash Flow

1. Project cash receipts from all possible sources. Includes cleared checks, credit card

payments, and cash itself (no orders) Note assumptions made when estimating

2. Subtract expenses that must be paid during the forecast time period.




Managing Inventoryto 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 Receivablesto 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 Payableto 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

(Cash Available + Revenue)Negative Cash Outflow per Month

= Number of Months Before Cash Runs Out




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




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.

entrepreneurship and small business management chapter 14 cash flow and taxes

Documents

cash flowingcollect

cash budget

cash flowtransaction

available cash

adequate cash

negative cash balance

poor gauge of cash flow

eby steve mariotti