Tuesday, November 30, 2010

A different approach to business plans

I wrote a short note to an old Marine Corps buddy who is launching a new business. This is what I wrote.
Here are a few things for you to think about as you get rolling.

You need to develop a one sentence description of your venture that captures the essence of what you plan to do. If you want to dust off your old field manual and use SMEAC that will work. Just be sure you cover the Who, What, Where, When, Why, and How.

Be sure you have a clear vision of what you are trying to accomplish. In the business planning world, this is called a vision statement. Figure out something that helps share your vision that is memorable and short. KISS is the acronym to remember for this one. “Keep It Short and Simple.”

You also need to have a clear understanding of your mission. One way to do this is to take the time to write out a simple mission statement.

If all of this sounds like the beginning of a formal business plan, that is because it is. Here are the basic components of a plan.

Overview of the business
Analysis of the market
Description of products
Organization and management
Marketing and sales plan
Financial details
If you have experience with business plans, most of this should be familiar, but what is SMEAC? If you have a military background, then you may recognize SMEAC as a Five Paragraph Order. The Five Paragraph Order, or some variation, is the format for virtually everything the military does. The initials stand for:

Admin and Logistics
Command and Signal

The armed forces are large bureaucratic organizations, and it is easy to poke fun at them. However, two things that the military does better than most are organizing and planning. For example the basic administrative tasks of military units are divided into four parts: 1) Personnel, 2) Intelligence, 3) Training and Operations, and 4) Supply. Those four groupings are clear, concise and complete. One of the ways that the military accomplishes its organization and planning tasks so well is that it has developed consistent methods and proven them over time. The processes are also simple and easy to remember. For example, when troops need to report enemy intelligence, they simply remember the acronym SALUTE which stands for Size (of the enemy force), Activity (of the enemy), Location (of the enemy), Unit, Time, and Equipment (of the enemy). This is simple and easy to remember. It also provides all of the information necessary.

SMEAC is an easy to remember way to organize a plan. It will work with big projects and small projects. It is simple, and it contains all of the elements that would normally be included in a business plan. The following explanation is simplistic, but it will help you to understand the concept.

This section is exactly what it sounds like. It is the section where you will provide an overview of the relevant facts and provide background information. This is also the place where you would explain the business opportunity.

This section is where you will explain what you will do. You do not need to explain exactly how you plan to do it. You will explain how in the next section.

In the previous section, you described what you were planning to do. In this section, you will describe how you will do it.

Admin and Logistics
This section will include the details to support what you say you will do in the Mission section. It will tie to how you plan to do it as described in the Execution section.

Command and Signal
In this section you will describe your organization.

As you can see, the Five Paragraph Order is clear, concise and complete. I’m not suggesting that you use it instead of the business planning formats that you already use for two reasons. The first reason is that if you are already comfortable with a process that works, you should stick with it. (If what you are already doing does not work, that is another matter.) The second reason is that most of the other people that you show your plan will be more familiar with a more traditional format. Even so, it is useful for you to understand this way of organizing your plan. It will help you to write a more complete plan and to write it more quickly. SMEAC is also so simple that you may find that you are able to take the time to plan that you may have done without planning in the past.

Sunday, November 28, 2010

Is tax deferred saving a bad idea?

The concept is appealing. Save money using pre-tax dollars in a special account. You can use the tax savings to put more money to work. The earnings in the account will not be taxed, and you will have bigger balance years from now than if you had saved after tax dollars in a taxable account. You will pay taxes on your withdrawals, but you may be subject to lower tax rates. You will be much better off than if you save after tax dollars in a taxable account. It sounds too good to be true.

I cannot tell you whether tax deferred accounts make sense for you. That decision should be based on your particular situation. However, before you automatically assume that it is a good idea to put money into tax deferred plan such as an IRA, SEP, 401(k), 403(b), or 457 plan, it makes sense to examine three basic assumptions.

Tax savings means a bigger balance
This may is true. However the tradeoff is that withdrawals will be taxable. Whether deferring tax will give you more after tax income is dependent on current and future tax rates. The biggest reason that balances are larger is that if a person was going to save $100, then he or she would have to earn $139 at a 28 percent tax rate to have $100 to save. The assumption is that people who would save $100 after tax dollars will save $139 pretax dollars. That assumption is not always true.

Tax deferred plans reduce your tax
This may also be true; however the statement is based on several assumptions. If the assumptions are false, which is possible, then tax deferred plans may not reduce your tax bill. They may even increase it. The blanket statement that tax deferred plans will reduce tax burdens is based on an assumption that tax rates will be lower when funds are withdrawn than when the income is deferred. There are several reasons that this might not be true.

One reason is that lifetime earnings follow a predictable pattern. People at the beginning of their careers tend to make less than people later in their careers. A healthy portion of the balance from a tax deferred savings plan is likely to have been set aside when income was relatively low. With progressive tax rates, lower income taxpayers pay tax at lower marginal rates. Of course the argument is that the money will be withdrawn at retirement and income will be necessarily lower. That argument is contrary to the reasons that people save for retirement. The income withdrawn from tax deferred plans will be taxable. If the taxable income is lower, then the plan did not accomplish the objective of accumulating a large enough balance to provide a replacement income.

Another reason that tax deferred plans may not reduce your tax is actually a collection of reasons under one heading: Tax is too complex a subject to make blanket assumptions. Here are just a few of the issues:
  • Future tax rates are unpredictable.
  • Social Security taxation is tied to other taxable income.
  • AMT is usually difficult to plan around.
  • If you experience a windfall, then you are likely to have higher income later, and that may mean higher tax rates.
  • If you save a lot, then you may have higher income later.
  • You may be living in a state without an income tax and plan to retire to a state with an income tax.
  • Tax deferred account earnings are taxed as ordinary income at withdrawal. This is true even if the earnings are the result of long-term capital gains or qualified dividends which may be taxed at lower rates.
  • Tax rate comparisons assume that alternative investments are taxable investments. This ignores tax-free investments. 
A question of control
In addition to the two assumptions explored above, there is also the question of control. The implicit assumption whenever a person uses a tax deferred vehicle is that he or she remains in control of the investment. This is true even though nearly all people know about age limits for penalty free withdrawals. The withdrawal limitations are a reasonable tradeoff for the tax deferral.

Control of funds in tax deferred accounts is actually a much bigger question than withdrawal limitations. There are two. The first is related to age. Tax deferred plans typically have some sort of required minimum distribution. This means that you will be required to withdraw some portion of your account regardless of your need for funds, and you will be required to pay income tax on the amount you withdraw. This is a huge amount of control to cede in exchange for tax deferral, and it is much more significant than having to reach a minimum age.

The second control question relates to how tax deferred accounts fit into your estate planning. This is a complex topic well beyond the scope of this article. However, the time to find out that tax deferred accounts may not be the best instruments for your estate plan is before you start putting a lot of money into them.

Is tax deferred saving a bad idea?
The answer to this question is dependent on a variety of factors. Tax deferred plans are neither good nor bad. Instead, they are tools that work well in some situations and not so well in other situations. If you are contemplating a tax deferred plan, ask yourself some question such as these:
  • What do you anticipate your income will be over your lifetime?
  • When do you expect to earn more or earn less?
  • What are your expectations about your future tax rates?
  • What does your expectation about your earnings and tax rates mean to you?
  • How important is it to you to be able to control your withdrawals in the future?
  • Do you have estate planning concerns?
What should you do?
The first thing you should do is to consider your situation. Ask yourself what you are trying to accomplish. If your objective is to shift income and defer tax, then use a tax deferred plan. If your objective is simply to save for some purpose, explore all of your alternatives and weigh the pros and cons of each. If a tax deferred plan is your best option, the use it. You may find that investing after tax income in a taxable account is your best option. It is likely that you will determine that you need some combination of tax deferred and taxable accounts.

If you are not sure what to do, seek advice from a professional. A CPA or financial planner should be able to explain your options and help you decide. If you have estate planning questions, then be certain that you seek advice from an attorney skilled in that area. If your situation is complex, you may want to involve several advisors with different skill sets.

Tuesday, November 23, 2010

Do you need a zero balance account?

A zero balance account is an account that usually has a zero or extremely low balance. Businesses use zero balance accounts to manage cash by moving money into the account only when it is going to be needed for a specific purpose. For example, payroll accounts are often zero balance accounts. Businesses will move the funds necessary to cover payroll into the account right before issuing paychecks, and then as employees cash the checks, the balance will drop back to zero. Zero balance accounts let businesses keep cash invested until it is needed. Zero balance accounts also help reduce exposure to fraud because it limits the number of people who have access to other business accounts.

Zero balance accounts are useful whenever a business makes routine or predictable payments out of an account. The most common example of this is payroll, but other examples could include rent or vendor payments.

So the question is, “Do you need a zero balance account?” The short answer is that you do if a zero balance account will help you put idle cash to work. While it may seem to be a lot of extra effort, many banks that provide cash management services can help you automate the process.

There is another reason to consider a zero balance account, and this reason applies to all businesses. It also applies to people that do not own businesses. The reason is fraud. Do you bank or shop online or use a debit card? Have you set up automatic debit transactions with vendors? A zero balance account can protect you. Consumers have a measure of fraud protection when they use credit cards. Business credit cards may not have the same protections. Debit cards may offer fraud protections, but legal protections may be limited. There are also some issues with automatic debit transactions.

Here is how a zero balance account could work for you. First establish a new checking account. Use a checking account because savings or money market accounts often limit the number of withdrawals that you can make. Keep your existing checking account. You use the same financial institution where you normally bank. That will make it easy for you to make transfers as necessary, and it will limit your additional recordkeeping. Try to use an account that allows a zero or very low minimum balance and either no fees or small fees. Some financial institutions will combine the balances of all of your accounts for the purposes of calculating minimum balances. You should also choose an account that will let you set up automatic transfers.

Once you have the account established, link it to your debit cards and online banking. Use the new account for automated debits and other predictable transactions. If possible, unlink your debit card from your old account. You can set up automatic transactions that will transfer funds from your first account to your new low balance account to cover your routine transactions. When you know that you are going to be using your debit card transfer the funds to cover your anticipated transaction. The idea is to limit your exposure to risk by limiting the amount of money in your account. Another way that it works is that setting up a cash management process that requires regular attention also increases your awareness so that if you are a victim of fraud or theft, then you will be able to respond more quickly.

Does a zero balance account makes sense for you or your business?

Sunday, November 21, 2010

Have you prepared your 2010 taxes yet?

Even though there is more than a month left in 2010 and tax deadlines are well in the future, it is not too soon to get started cleaning up your books and preparing to file your taxes. Getting started now can help you by reducing the amount that you spend on bookkeeping, accounting, and tax services, and it could reduce the size of your tax bill. If you begin reviewing your tax situation now, you will also have some time for last minute tax planning for 2010.

Getting started
The first thing you need to do is to get your books in order. Whether you have a full-time bookkeeper or simply save everything in a shoebox for your CPA, a little organizing can go a long way. If you need more guidance than this brief article provides, contact your bookkeeper or CPA. They will be happy to tell you how to improve the way you organize your records. What you pay for an hour or two of consulting will be more than offset by the money that you can save by being organized. Your CPA or bookkeeper might even provide the consultation for free. You may even decide that working more closely with your professional accountant will give you more time to spend on the rest of your business.

Separate business and personal
Make sure that your personal and business lives are separate. This seems obvious, but every year small business owners or employees with unreimbursed expenses turn over business records comingled with personal records. It may be too late for 2010, however you should make sure that you have different bank accounts and credit cards for your business and personal lives. You may not need special business accounts, but you should make certain that they are separate.

Get your books in order
There are a couple of important parts to this step. The first step is to organize your records the way that CPAs and bookkeepers do. Figure out all of your sources of income and group them into logical categories. Then organize all of your expense. Business owners tend to focus on expenses because they worry about cash flow. However most people used to working with money are accustomed to seeing revenue, then expense, then net income. It is not a bad idea for you to think in that order also. If you think about it, the success of your business depends on money coming in the door, not just your ability to control expenses. Income and expense groupings are not just for business. If you organize your personal records this way, you will find your personal record keeping easier. An added bonus to organizing your records this way is that bankers also expect to see your financial statements in this order. If you ever need to complete a credit application, it will be easier for you to find the information that you need.

Once you have grouped your records into the two large categories of income and expense, further categorize the records by type. How you do this will depend on the type of business you own. If you have W-2 income then keep that apart from business income. You will want to group business income by whether it was for services or goods. A quick note about employee business expenses is in order at this point. If you are organizing your records because you have employee business expenses, you will want to sort out any payments that you received for expenses by whether they were taxable or nontaxable. Your employer should be able to tell you this.

After you have categorized your income, do the same with your expenses. If you already have a bookkeeping system with a set of accounts, then simply use those accounts. This is a good time to review your chart of accounts for completeness and accuracy. If you do not already have a way to categorize your expenses, take a look at your previous tax returns and see how your CPA divided up your expenses. Your CPA may even have a tax organizer that you can use. Depending on the arrangement that you have with your bookkeeper of CPA, this process could be as simple as organizing your receipts and statements, or it could include entering the expenses into your bookkeeping system. If all of this is getting unwieldy for you, then this is a good time to talk to your CPA or bookkeeper about how they can help you manage your books.

What about records that you do not yet have?
You will not receive some statements or reports until the end of the year or even until January or February. No problem. Set up folders for the statements or reports that you expect to receive later. Then when you receive them, simply add them to the appropriate folder.

How this helps
This may seem like a lot of work that could just as easily wait until later. However, by beginning now, you will be more likely to have everything you need later when you take your files to your CPA. In addition, having complete and well organized records makes your CPA’s task easier so that he or she can work faster. That will save you money. In addition, complete and well organized records will make it less likely that your CPA will miss something, and in the event that your return is selected to be audited, good documentation will make the audit much easier for you.