Budgets and Forecasts, Anyone?

How do you spend money at home?  Most people would answer this question with, “very carefully.” That’s a good thing.

A solid financial, savings and investment plan is critical to achieving long-term success. So, how many small business owners have a budget?  I would think the answer to this is “not many.” Why the difference?

Well, it could be a lot of things. Maybe the top answer is: “budgeting takes too long” or, “once it’s done, it’s out of date.”  I won’t argue with those answers.

Budgeting and forecasting aren’t fun. But it is a crucial tool to have your business stay on track to being cash-flow positive. The fact is that the budgeting process compels owners and managers to think through how the business makes, and loses, money. Only when someone is required to budget or forecast revenue that they consider the quantity and price, or rate of goods or services, that must be sold that they confront how a business brings in revenue.  Ditto for costs.

Doing this annually, or more often (forecasting), will reveal changes in the business – changes that need to be addressed for continued success.

Question: How many of you know how much money you need to purchase equipment over the next year to stick to your business plan?  

If you don’t know that answer, it’s likely you will make a mistake at some point and lose money that you would otherwise make or keep.

Tools for Budgeting and Forecasting

Most accounting software, even Quickbooks, has budgeting functionality. Simply running a report that compares actual revenue and expenses to budgeted figures will force you to answer the questions of why your actual results don’t equal your budget. Your answers will give insight into how your business makes money.

Excel is always an option, but I recommend Excel only for calculations that show how your budget was calculated. Excel is invaluable for doing a lot of math in a short amount of time. But data integrity is not its strong suit.  A budget in your accounting system is the best way to reduce the risk that you are missing something.

Research and Development Credit

While the research and development credit (R&D credit) must be renewed yet this year, it almost always is. If your business does research to improve your products, and is technical in nature, you may be eligible for a federal tax credit.

As more companies build software in-house, these companies may be eligible for the credit.

The Research and Development credit is calculated as much as 20 percent of qualified research over a threshold amount (subject to some limitations).

Qualified Research means research which is undertaken for the purpose of discovering information which is technological in nature. And the application of which is intended to be useful in the development of a new or improved business component of the taxpayer. Substantially, all of the activities of which constitute elements of a process or experimentation for a new or improved function, performance, reliability or quality.

Qualified expenditures include wages and supplies for in-house research, as well as 65 percent of payments for research to qualified institutions. Qualified Institutions include eligible small businesses, universities and federal laboratories.

Startup companies can qualify for a pro-rated credit.

Rents and Royalties

Does your business get part of its revenue from renting space or equipment, or licensing the right to use a copyright, trademark or other intangible assets?

If you are structured as an “S” Corporation, too much of this type of revenue can put you at risk of losing your S Corporation status. And subject your company and you to an additional tax.

Under certain circumstances, having such “passive” income greater than 25 percent of your total revenue for too many years in a row can terminate your “S” election and reclassify your legal entity as a “C” Corporation, of which shareholders are subject to double taxation.

What Is Revenue?

Beginning in 2018, new revenue standards will be effective. it is a water-shed piece of rule-making that consolidates hundreds of pieces of guidance that have accumulated over decades.

Another significant aspect to this standard is the role that certainty of cash flow plays.

Under Accounting Standards Codification 606 – Revenue from Contracts with Customers, if you bill your clients as your work progresses (construction companies often do this; it’s sometimes referred to as “percentage-of-completion”), if the contract with a customer does not specifically state that if they were to stop the project, billings up until that point are payable to you, then you may not be able to recognize that revenue.

Why is this important? Does your business have a loan with a covenant that requires a certain level of profitability?  If so, this could reduce the revenue your business shows on its financial statements, which could put you in violation of that requirement and permit your lender to call in the loan.

SHAMROCK vCFO Services in Naperville, IL specializes in helping small and medium size businesses with strategy, taxes, accounting, and financial performance management. Steve Shamrock left big companies to help smaller ones energize the economy.