Don’t Cook the Books: Accounting
Even if you are famous for saying “I’m not good with finances,” as a small-business owner, you need to at least know the basic dos and don’ts for managing your business’s finances. In this chapter you will find suggestions for maintaining good cash flow, how to arrive at accurate pricing for your products and services, and how to figure the break-even point for your specialty foods business as well as a few simple tax tips.
How you manage your financial assets may determine whether your business succeeds or fails. Your capital is not merely a collection of money and property, but a powerful business tool deserving your careful attention. Because going into business for yourself is such a risky proposition, it’s helpful if your capital yields a higher rate of return than an ordinary investment would. Making capital work for you requires careful management of your business, especially of your current and future assets.
Financial management is an area many small-business owners neglect. They get so caught up in the day-to-day running of their businesses that they fail to take a good look at where their money goes.
It all starts with keeping good records in order to generate the financial statements that tell you exactly where you stand and what you need to do next. The key financial statements you need to understand and use regularly are:
Profit and loss statement (also called the P&L or the income statement). This statement illustrates how much your company is making or losing over a designated period—monthly, quarterly, or annually—by subtracting expenses from your revenue to arrive at a net result, which is either a profit or a loss.
Balance sheet. A balance sheet is a table showing your assets, liabilities, and capital at a specific point. A balance sheet is typically generated monthly, quarterly, or annually when the books are closed.
Keep Abreast of Trends
All business owners need to keep on top of trends in their field, and specialty food is no different. From going green (organic food sources, packaging, etc.) to trends toward unusual and interesting ethnic foods, you can do some of your research standing in front of the local magazine rack.
Check out which magazine sections are largest and which magazines are thickest—the thicker the magazine, the more advertisers, which means the higher the circulation of the magazine, which means more readers, which means more people interested in that topic. Browse headlines for what those magazines are writing about.
Cash-flow statement. This summarizes the operating, investing, and financing activities of your business as they relate to the inflow and outflow of cash. As with the profit and loss statement, a cash-flow statement is prepared to reflect a specific accounting period, such as monthly, quarterly, or annually.
You will need to review these reports regularly, at least monthly, so you always know where you stand financially and can quickly move to correct minor difficulties before they become major financial problems.
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Check out local community colleges, recreation departments, and other sources of noncredit classes where you can often find a financial class specifically aimed at those thinking about starting a small business. This is a great way to learn about financial reports and have an instructor to whom you can direct specific questions. And you get to meet other people in your same shoes who may become part of your trusted circle of small-business friends.
Although it might seem easy to organize cash flow as a startup since there might be very little initially, you may actually get so caught up in the other aspects of your daily routine that you forget to send an invoice or remind a customer that a payment is overdue. You might want to consider online invoicing tools like FreshBooks, or QuickBooks, which allow you to set up automatic reminders and acknowledgments. Even after your startup is built out and you are generating revenues, these tools will scale up with you and continue to keep your business organized. Many offer more features that you can add later on to handle larger volumes and projects so you never lose that efficiency that helped you from the start.
Keeping enough money flowing into a business is a universal concern, but the problem can be thornier in some types of specialty food businesses. For instance, if you are creating large orders for which you need to purchase supplies and pay employees well in advance of ever getting paid, you will want to make sure to require a deposit that allows you to purchase what you need and to set up accounts with vendors with terms that allow you to pay after you have received payment from your customer. A couple of other tips to alleviate cash-flow concerns include:
1. Start with plenty of cash reserves. Make sure that the amount you estimated in for your startup time period is realistic.
2. Charge enough for your products and services. Make a careful assessment of what you need to charge to turn a healthy profit. Otherwise, you will end up financially frustrated. In retail, you can always lower your prices if you find a particular product isn’t selling. Remember that controlling costs is easier than trying to predict what your revenue will be. Once you look for additional ways to save money, you’ll find them. That said, don’t be “penny wise and pound foolish” and end up having your expense cutting cost you more indirectly.
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Whenever possible, save money by bartering services with other business owners. Perhaps you could provide food items for a meeting in exchange for brochure printing services or the creation of signage.
The goal in pricing a product is to sufficiently cover overhead expenses (lights, heat, etc.) and cost of production (employee costs as well as materials) and generate an acceptable profit. The Vermont Specialty Foods Manual (published on www.vtspecialtyfoodbusiness.com) says you need to take all of the following into account when pricing your specialty food products:
Direct costs. These are the cost of things tied directly to the production of your product such as ingredients, packaging, and wages for production workers.
Guaranteed sales. This actually refers to product that you wholesale that does not sell but is returned by the retailer (i.e., the retailer’s sales are guaranteed or they return unsold product).
Overhead costs. Anything you need to spend to be in business that isn’t directly tied to the cost of producing your product.
Profit needs. What kind of profit (you can work with percentages but the dollar amount of your profit tells you how much actual money you will have to pay for these other things) does it take to keep you in business?
Distribution. Even if you distribute yourself, it takes time, gas, wear and tear on a vehicle, and perhaps lease or purchase of a vehicle. If you use a distributor, you need to price their margin into your product markup.
Population served. The income level of the population in the area in which you set up business (for local retail) will in great part determine how much you can charge for your products. If you want to charge more than the local economy will bear, you need to either set up shop somewhere else or focus on mail order where you can reach the demographic to whom you wish to sell no matter where you are physically. You could still have a retail shop connected to your mail order business; you could charge lower prices in your shop to meet the market and call it your “factory outlet store.”
Experience and reputation. You do need to gain some reputation in order to charge top prices or you need testimonials from trusted, well-known people in order to come out of the box charging the highest tier of prices.
Price of similar specialty food products currently on store shelves. You can under or overprice your product compared to other similar products but you had better back up your reasoning. If you price higher, your product better be that much better! If you price lower, your product likely will still need to be considered comparable to the higher-priced product. Find cheaper ways to package, print labels, distribute—cut corners in anything but the food itself!
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Even the smallest expenses add up. Supplying doughnuts and coffee at morning meetings with your staff is great for morale and helps to keep your team happy, but be sure to include a “doughnut allowance” when you calculate expenses!
One way to help with cash flow is to sell gift certificates. People love to buy gift certificates for gifts if you sell several different products—gift certificates allow the gift recipient to purchase what they like from your offerings. Or if you sell perishable foods, the gift recipient can purchase when they want the items and not have to eat them when given.
You can also offer gift certificates at discounted prices ($100 gift certificate for $75, e.g.,) or with a bonus (buy a $100 gift certificate and get a free $25 certificate) especially during the off season.
Gift certificates are a bit like money in the bank because often people wait months before cashing them in.
Industry markups vary widely, ranging from 100 percent and up. Markup rates depend mostly on overhead costs, but the health of the economy also affects them. In troubled economic times, markups (and therefore profit margins) will be lower. According to Jose Maria Pertusa (www.quora.com/What-are-common-gross-margins-or-just-retail-markup-for-a-high-end-food-store), “Brick-and-mortar gourmet food retailers operate at a 30 to 70 percent gross margin.” Higher-value items, he says, have lower margins while lower-value items tend toward the higher margins.
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An additional way to beef up your cash flow on contract/catering type work is to consider requiring clients to pay your bill in three installments rather than two. The first is the deposit, the second is a progress payment, and the third is due at the time of delivery. Note that if you do this, you will still probably want to have clients pay an initial deposit of close to 50 percent.
Along with opening your business with adequate cash reserves, requiring deposits, and charging appropriately for your services, there are several other ways of ensuring good cash flow for your business:
Pay your company’s bills on time, but do not pay early. Keep your money in the bank as long as possible. The single exception to this rule applies if you have negotiated vendor discounts for early payment. Organize files by bills due in 10 days, 20 days, 30 days, etc. Choose a day, say Monday, and pay the bills due in 10 days. Then move the bills due in 20 days to the bills due in 10 days folder, the bills due in 30 days to the due in 20 days folder, etc. If you pay online, you could even change “10 days” to “due in two days” but don’t cut it too close just in case you get distracted and don’t get to your bills that day. Don’t pay early but also avoid any late fees.
Make sure your invoices are clear, accurate, and timely. When you do contract work, send invoices promptly. The difficulty of collecting an account increases in direct proportion to its age. Better yet, have the remainder of the bill (minus deposit) due when you deliver the goods. You hand a invoice, you get a check and mark the invoice paid. Always itemize invoices so clients know exactly what they are paying for.
Keep inventory and supplies to a minimum. Carrying excess inventory can seriously impact cash flow. There are few things in this day and age that can’t be had on almost a just-in-time basis.
We have cautioned you to make sure you have a substantial amount of operating capital, enough to last until you reach the break-even point. First you need to figure out your monthly costs that you will incur no matter what happens with the rest of the business. That is, you need to heat your retail shop and pay the person who runs your cash register no matter whether you produce a single piece of fudge or sell a single jar of salsa. So first, you need to:
Loss Leader
Almost every business has one or two items that are huge sellers but whose profit margin is very low or even nonexistent. You don’t want any of your products to lose money. But if you make giant whoopie pies with high-quality ingredients that are time consuming to carefully produce, you may find that this is what brings customers to your door but what you really make money on is that 90 percent of your customers can’t resist buying six other higher-profit items when they come in for that whoopie pie fix. So your loss leader may be a great revenue generator even though it doesn’t make much of a profit itself, but its biggest contribution is luring in customers who buy other things while they are in the store.
Determine your monthly fixed costs. Fixed costs are those that do not change, no matter how much product you produce (e.g., rent, utilities).
Determine your variable costs. Variable costs are the costs of producing your various products, with varying quantities.
Estimate sales. Estimating sales is difficult before you have ever even opened your doors but it can be done. You will want to determine how many people might come through your doors in a given time period and the average amount each of those customers might spend.
Determining the right margin to make an appropriate profit on all sales will be the key to how much you need to bring in in order to break even.
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Although you should strive for an accurate estimate, you may find that your final total differs from the initial estimate. For this reason, you should make it clear to your clients that your estimate is just that—an estimate. Make sure that this fact is stated clearly in your contract. Ensuring that you do not exceed your estimate by an unreasonable amount is an important part of your responsibility to your client.
Managing your finances includes keeping a careful eye on your tax liabilities. These include:
Sales taxes. Sales taxes are levied by many cities and states at varying rates. Most provide specific exemptions for certain classes of merchandise or particular groups of customers. Service businesses are often exempt altogether. Contact your state and/or local revenue offices for information on the law in your area so you can adapt your bookkeeping to the appropriate requirements.
Personal income taxes. If you are a sole proprietor or partner, you will not receive a salary like an employee. Therefore, no income tax will be withheld from the money you take out of your business for personal use. Instead, you must estimate your personal tax liability and pay it in quarterly installments.
Corporate income taxes. If your business is organized as a corporation, you must pay taxes on all profits.
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You must keep records to determine your tax liabilities. Regardless of the type of bookkeeping system you use, your records must be permanent, accurate, and complete, and they must clearly establish income, deductions, credits, employee information, and anything else specified by federal, state, and local regulations. You must keep complete and separate records for each business.
In addition to paying your own taxes, as a business owner and employer you will be responsible for collecting employee state and federal taxes and remitting them to the proper agencies. If you are a sole proprietor and plan to hire an employee, call the IRS at (800) TAX-FORM or access the information at www.irs.gov. Ask for a copy of Form SS–4. Also call your state tax agency.
Do not mess around with taxes. If you don’t want to get familiar with the laws (and maybe even if you do), hire an accountant who will take care of your tax issues and let you know what you need to do when.
You may hire some individuals as independent contractors if, for instance, you cater the occasional event. According to the IRS definition, independent contractors are individuals who perform services for more than one firm, determine how the work is to be done, use their own tools, hire and pay their own employees, and work for a fee rather than a salary. If you hire independent contractors, you have to file an annual information return (Form 1099–Miscellaneous) to report payments totaling $600 or more made to any individual in the course of trade or business during the calendar year. If you do not file this form, you will be subject to penalties. Be sure your records list the name, address, and Social Security number of every independent contractor you hired, along with pertinent dates and the amounts paid to each person. Every payment should be supported by an invoice from the contractor. Be warned also that if the IRS feels a worker whom you treated as a contractor should have been treated as an employee, you will be liable for payroll taxes that should have been withheld and paid, plus penalties and interest.
Tax Planning
Good tax planning not only minimizes your taxes, it also provides more money for your business. As an entrepreneur, you should view tax savings as a potential source of working capital. There are a few important rules to follow in your tax planning:
Don’t incur an additional expense solely for the sake of getting an extra deduction. This strategy is not cost effective.
Immediately deferring taxes allows you to use your money interest-free before paying it to the government. Interest rates may justify deferring taxes, though doing so may cost you more taxes in a later year.
If possible, claim income in the most advantageous year. If, as you begin your business, you are employed by someone else and expect to receive a year-end bonus or other additional compensation, you may want to defer receipt until the forthcoming year, especially if you will be in a lower tax bracket at that time (e.g., perhaps quitting your job to devote full time to your business).
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All withheld income tax is treated as if spread equally over the calendar year, even when a disproportionately large amount is withheld in December. If you are required to make estimated tax payments, you should pay special attention to other techniques that may be beneficial, especially if your income is irregular or seasonal. Check with your accountant.
Most small-business owners have some standard deductions they can claim to help offset taxes:
Home office. You can deduct for all normal office expenses plus interest, taxes, insurance, and depreciation on the portion of your home that you use exclusively for business. To deduct, however, you must satisfy the following four usage criteria: exclusive use (the space is not used for anything else), regular use (occasional use doesn’t qualify), business use (you must conduct business in that space), and administrative use (you must handle administrative tasks at that location). Be aware that the IRS has traditionally audited a high percentage of taxpayers with home offices.
Computers. A home computer used exclusively for business may qualify for appropriate business deductions or credits.
Automobiles. Depending on which method you use, you may deduct for mileage or for mileage plus depreciation, garage rent, insurance, and repairs, among other expenses.
Travel. You must stay overnight on business to claim deductions on air, bus, or auto fares, hotel bills, and incidentals like dry cleaning and gratuities.
Entertainment. You can deduct 50 percent of your expenses, but you must maintain records of the following: amount of expenditure; date of expenditure; name, address and type of entertainment; occupation of the person entertained; reason for entertainment; and the nature of the business discussion that took place (general goodwill is not accepted by the IRS). Rules for deductions change frequently. You can also look online at www.irs.gov for tax updates.
Conferences and seminars. The cost of the actual seminar is deductible, but deductions are no longer permitted for many of the expenses (e.g., food, lodging) incurred in connection with a conference, convention, or seminar.
Dues and subscriptions. You may deduct these as long as they pertain to your field of business.
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Make sure you do not make a mistake about what is tax-deductible. Penalty rates are high. Check with your accountant to be sure your deductions are legitimate. An IRS audit is not only inconvenient, it could be costly.
With proper management of your company’s financial resources, you can greatly increase the probability that your business will succeed. Hiring the services of a competent bookkeeper to keep the day-to-day expenses well-recorded and an accountant to deal with the annual tax submissions is a great way to keep on the good side of the IRS and avoid nasty surprises.