Inflation has reared its ugly head over the last couple of years, and while it seems to have settled down a bit in 2023, forecasters are predicting 2024 will be a wild ride.

Inflation reduces the purchasing power of your money; you pay more and get less. The impact can be severe, affecting supply chain, cash flow, and profit margins.

Costs of raw materials, supplies, and utilities are rising faster than you can increase prices. Employees want higher wages to handle their own inflation woes. The cost of borrowing keeps rising, making it difficult to finance investments in the business.

And consumers tend to spend less during times of increasing inflation.

How can you adapt your business and thrive during these crazy times?

1. Employee retention is key. There is a labor shortage, and good people are hard to find. The cost of replacing employees is much higher than many employers realize; in some cases, the cost can be as much as 100% of an employee’s annual salary. Employees want higher wages since they are facing their own inflationary problems. But there are other ways to retain good employees outside of increasing wages; you can offer flexible work hours or additional paid time off. You can also think of simple things to increase morale, like bringing in lunch once a week.
2. Look for local suppliers if you are experiencing supply chain backups. Try to diversify the number of suppliers you use and compare their pricing regularly.
3. Review processes and look for ways to streamline and improve efficiency. Encourage feedback from employees, especially those who are most productive.
4. Manage your inventory. While it is comforting to have a stockpile when your supply chain is still experiencing holdups, the cost of carrying too much inventory is high. Not only does it mean cash out of your business, but there is also the cost of warehousing and managing the inventory. You also run the risk of obsolescence.
5. Review your pricing strategies. Raising prices must be carefully evaluated in terms of competitors’ pricing, strength of your customer base, and perceived value. Look for ways to increase the perceived value of your products/services to offset the effect of the increased prices.
6. Update your marketing and advertising strategies. Look at advertising methods you have not used in the past and evaluate if they might be worth a try.

There are three critical statements that should be included in every business reporting package: the Balance Sheet, the Income Statement, and the Cash Flow statement.

The Income Statement, sometimes called the Profit and Loss Statement, is a record of the revenues and expenses over a certain time period; monthly, quarterly, or annually.  Remember that an Income Statement is a record of past events. It is used to see what happened in the past, not what will happen in the future.

While an Income Statement shows the profitability (or losses) of a company, it does not show the cash flow or position. A company may show a profit on the Income Statement, but if customers are late in paying, you prepay expenses, or you have loan payments, your cash position might be in trouble. That is why you need all three statements for a good evaluation of the health of your company.

The Income Statement is used by the owner of a business to determine how profitable the company was over a specific period of time. It is also used by investors to verify the company will provide a return on their potential investment. Finally, this statement is used by banks and other lenders to ascertain the ability of the company to repay any loans.

The Income Statement should be prepared monthly or at the very least, quarterly. Banks and investors will often ask to see prior year income statements to compare the growth and profitability of your company over time. The income statement is also used by your CPA to prepare your tax returns.

The Income Statement has three or four main components: revenues, cost of sales, general and administrative expenses, and other income/expense.

Revenues:

These can be detailed by sales categories. Products and services can be broken down by type.

Cost of sales (COS) / Cost of goods sold (COGS):

1. If you manufacture products for sale, this includes the costs of raw materials, direct labor, overhead allocation, and freight costs.
2. If you purchase products for resale, the costs of these products and related freight charges are included, as well as any inventory storage costs.
3. If you sell services, your costs of labor for these services are included. Also include any benefits for this labor.

Gross Income = Revenues less COGS

Selling, General and Administrative Expenses (SG&A):

Salaries and wages (non-manufacturing), payroll taxes and benefits, rents, telecommunications, advertising, insurance, supplies, depreciation

Operating Income = Gross Income less SG&A expenses

Other Income (Expense):

Interest income, interest expense, gain or loss from sale of assets, bad debt expense

Earnings before taxes (EBT) = Operating Income plus Other Income less Other Expense

Provision for Income Taxes

Net Income (Loss)

A sample Income Statement:

Contact your accounting professional if you have more questions about financial reporting for your business.

Fixed assets are items that are used in your business’s ongoing operations for longer than a year. These items should not be “expensed” or shown on the Profit and Loss Statement; instead they should be recorded on the Balance Sheet as assets. They are expensed over time through depreciation. Examples of Fixed Assets are:

• Machinery and equipment
• Furniture and fixtures
• Vehicles
• Computers and Software
• Land
• Buildings
• Building Improvements
• Leasehold Improvements

Fixed Assets are recorded on the Balance Sheet at the purchase price plus any installation costs needed.  Once a Fixed Asset is put into service, except for land, it begins to lose value. This loss in value is accounted for with Depreciation (for tangible assets) or Amortization (for intangible assets like software).  Depreciation and Amortization are non-cash expenses in that they are included in your Profit and Loss Statement even though there is no cash transaction.

Different Fixed Assets have different useful lives so are depreciated over different periods. There are a number of depreciation methods, but the two of the most common are:

1. Straight-line depreciation is the simplest. Take the original cost of the Fixed Asset, subtract any expected Residual Value (if you think you will be able to sell the asset once you are no longer using it), and divide the result by the number of years you expect to use the asset.
   • For example, you purchase a computer for $2,000 and expect to use it for three years, after which you think you can sell it for $200. The annual Depreciation Expense will be $600.
   • ($2,000 – $200) / 3 = $600
2. Unit of Production method us often used for machinery used in production. Take the asset cost less any residual value and divide that by the number of units of production expected from the machine. Then multiply the Per Unit Depreciation expense by the actual number of units produced during that period.
   • For example, you purchase a printing press to print flyers for $10,000 and expect to be able to sell it for $1,000 when you dispose of it. The press will be able to print 100,000 units over its useful life. The per unit of depreciation will be .09 (nine cents).
     • ($10,000 – $1,000) / 100,000 = .09
   • During the first full year of operation, you print 10,000 flyers. The depreciation expense for that year will be $900.

The IRS has rules for fixed assets and depreciation, and those rules can change. It is important to work with an accountant who understands the proper way to classify fixed assets and the most beneficial method of depreciation.

Many business owners think the terms Income Statement and Financial Statement are interchangeable. The Income Statement is indeed one part of a Financial Statement package, but owners should know there are usually three other statements and why they are important.

There are four basic financial statements are:

• Income Statement
• Balance Sheet
• Statement of Cash Flows
• Statement of Changes in Equity

Let’s start with the Balance Sheet.

The balance sheet is made up of three sections: Assets, Liabilities, and Equity. The basic accounting equation is Assets = Liabilities + Equity. The balance sheet shows a company’s financial position on a specific date.

Assets

Assets are the resources of the company that have been acquired through past transactions and have future economic value. Examples of assets are:

• Cash in Bank
• Accounts Receivable (amounts due from customers)
• Inventory (merchandise for re-sale or materials to be used in production)
• Prepaid Expenses (items paid in advance like insurance and property taxes)
• Land
• Buildings
• Machinery (used in manufacturing production)
• Computer Equipment
• Software
• Trademarks, Patents, or Copyrights

Assets are classified into distinct groupings.

• Current Assets are assets that will generally be used within an accounting cycle. They include cash, accounts receivable, inventory, and prepaid expenses.
• Fixed Assets are items that provide long-term use for the company. Things like land, buildings, machinery, and computer equipment will benefit a company for longer than one accounting cycle.
• Intangible Assets are those items that are not physical and will last longer than one account cycle, like computer software or trademarks.

Liabilities

Liabilities represent obligations for past transactions that must be paid by a company. Liabilities can be thought of as a source of the company’s assets and claims against those assets. They include:

• Accounts Payable (amounts due to suppliers)
• Short-Term Notes Payable (the portion of any loans due within one year)
• Wages Payable (amounts due to employees but not paid as of the date of the statement)
• Interest Payable
• Customer Deposits (advance payments received for work or goods not yet provided)
• Accrued Expenses (obligations that have been incurred but not yet recorded in Accts Payable)
• Notes Payable

Liabilities are also classified into groupings:

• Current Liabilities are obligations that are due within an accounting cycle. Accounts payable, wages payable, customer deposits, and accrued expenses are examples of Current Liabilities.
• Long-Term Liabilities are obligations that are due over more than one accounting cycle. Notes payable (less the current portion shown in Current Liabilities) are listed here.

Equity

The items listed in the Equity section vary, depending on the legal form of the business. Owner’s Equity is used when a company is a Sole Proprietorship; Members’ Equity is used for a Limited Liability Company; Stockholders’ Equity is used for a corporation.

The Equity accounts for a Sole Proprietorship will include:

• John Smith, Capital
• John Smith, Draws
• Net Income (cumulative for the current year)

Equity accounts for an LLC are:

• Members’ Equity
• Members’ Draws
• Net Income

Equity accounts for a corporation include:

• Common Stock (shows the original cost of the company shares sold to stockholders)
• Preferred Stock (not every corporation has this)
• Retained Earnings (the cumulation of net profits/losses from prior years)
• Net Income

An accountant who understands how to properly classify items on the balance sheet is crucial to having useful financial statements. Staying on top of accounts receivable is essential for good cash flow; knowing how often inventory turns over can help you determine if you are carrying obsolete items; recognizing when an item should be recorded as a fixed asset and when it should be expensed will keep you out of trouble with the IRS.

You may have heard the terms Cash Basis or Accrual Basis, and when you register your business with your state, you will likely be asked which method you plan to use. This is an important decision, but the concepts are not difficult. It is worth the time to understand what the terms mean.

The bottom line is that the Cash Basis and Accrual Basis of accounting are two different methods of recording transactions. The difference between the two is the timing of when Revenues and Expenses are recognized.

The Cash Basis records revenue when cash is received from a customer; expenses are recorded only when cash is paid to suppliers and/or employees. The Cash Basis is the easiest to use of the two methods – there are no payables or receivables to worry about. Another is that taxes are paid only on transactions that have been paid. However, per the IRS the Cash Basis can only be used when a company’s sales are less than $5 million per year.

The Accrual Basis means revenue is recorded when an item is sold or when a service is performed, not when payment is received, and expenses are recorded when the items are used. In other words, revenues are recognized at the time they are earned, Cost of Goods Sold are matched and recorded at the same time, and administrative expenses are recorded when incurred.

Example 1

A company sells 500 widgets for $1,000 to a customer in June. The customer pays the invoice in July. With the cash basis, the sale is recorded in July when the cash payment is received. Under the accrual method, the sale would be recorded in June when the invoice is issued, and an Accounts Receivable would be created. When payment is received in July, the cash is applied to the Accounts Receivable.

Example 2

A company buys $100 of office supplies in September and pays for them in October. Under the Cash Basis, the expense is recorded in October when paid. With the Accrual Basis, the expense is recognized in September when the invoice is received and an Accounts Payable is created.

The consequences of choosing the wrong method can be expensive. I once had a client who had a small retail company and chose the Accrual Method. He was able to get a substantial discount on items for resale, so he actually saved money by purchasing more than he needed. He classified the extra goods in inventory, even though most of those items would never be sold. The correct method would have been to use the cash method and classify all purchases to expense when payment was made. Consequently, he showed higher profits which meant he had a bigger tax bill each year.

Starting a business can be one of the most exciting things you do in your life. You have a great idea and you have figured out a way to make money with it. So let’s get things going!

Fire! Aim! Ready!

Slow down. Some careful thought, foresight, and planning will go a long way to increase your chances of success. A methodical plan of action will help you to fulfill your dream of being your own boss and running a successful business. The steps below are the start to a basic action plan for the beginning stages of your business.

1. Prepare a Business Plan to clarify your marketing, management, and financial plans. While this task may seem unnecessary and even daunting, especially if you have never seen a Business Plan, this one thing alone will do more to help your business succeed than anything else you can do. A well-thought out Business Plan will help you to crystalize your motives for starting this business, who your competitors are and how you will compete with them, and how much money you will need until the business becomes profitable. (The elements of a solid Business Plan will be detailed in my next blog post.)
2. Determine how much capital you need to take you through the first two years of business. Following the steps of a sold Business Plan will help you consider all the different factors in projecting cash needs. Identify your sources of capital, whether they include your own savings, partner investments, or loans.
3. Select a business location. Some businesses can be run from your home or a small office, others might need industrial space, and still others will need a retail-type site. If your business is in the third category, selecting a location is the second most important thing you do. Your location will affect not only the quantity and quality of traffic that passes each day, but different cities have very different taxes, regulations and licensing requirements that should be considered.
4. Select a business structure that best fits your needs by evaluating tax advantages, legal exposure, and ease of compliance. Whether you operate as a Sole Proprietor, a Limited Liability Company, or a Corporation is entirely your choice, but each structure has different filing and tax aspects that need to be considered. You can consult with a general business attorney, a CPA, or a seasoned accountant to help you with this decision.
5. Register your business name or trade name. If you are going to operate as a Sole Proprietor, you should register a DBA (doing business as) with your state. If you plan to operate as an LLC or a corporation, you need to verify that your chosen name is not already taken and then it must be registered with the state. When choosing a name, think about whether you plan to have a website and check to see if the matching domain name is available. You might also need to consider trademark possibilities, in which case you need to check with the U.S. Patent and Trademark website.
6. Register with the IRS to obtain an EIN (employer identification number).
7. If you expect to collect sales tax from customers, you will need to apply for a sales tax permit from your state.
8. If you will have employees, you need to register with your state for income tax withholding.
9. Find out if the city or township in which your business resides requires any kind of business licensing.
10. Open your business bank account. You will need your EIN and a copy of your Articles to do this. When selecting a bank, consider the convenience of branch locations as well as fees and charges assessed to your account.

These steps may seem daunting, but a seasoned business professional can help walk you through these tasks to make sure you start your business the right way.