The HBS Blog offers insight on Delaware corporations and LLCs as well as information about entrepreneurship, start-ups and general business topics.
Of all of the exciting things that come with running your own your business, setting an annual budget is rarely near the top of anyone’s list. In fact, many entrepreneurs never get around to it, or do a half-hearted job, as they get caught up in the excitement of pursuing their dream. But those who don’t are making a big mistake, one that can make the difference between survival and failure, particularly in today’s challenging economic climate. Fortunately though, while setting a budget will never be the most thrilling part of being an entrepreneur, it can be a relatively painless one.
In order to create a budget you’ll probably want to use QuickBooks or some other accounting software, and you should actually produce two types of budgets: an operating budget and a cash-flow budget. This week we’ll focus on the operating budget, which can then be used as a template to construct the cash-flow-budget.
The operating budget should list of all of your projected revenues and expenses for a one-year period. It can be helpful to start with the expenses, as they are usually easier to quantify. Begin with your fixed costs like rent and insurance that are unlikely to change throughout the year, and then move on to include your best assumptions for variable costs such as marketing and travel expenses. Make sure to include everything that you will need to spend money on to keep your business running, down to the smallest expense.
The next step is to tackle the revenue side of the budget, and the most important thing here is to be realistic. This means that if you’re just starting out you shouldn’t assume that you’re going to hit the ball out of the park right away, and if you’ve been at it for a while you shouldn’t be projecting that you’re going to enter into a high-growth phase all of a sudden.
In forecasting both the revenue and expense sides of your operating budget, flexibility is the key to coming up with a set of numbers that are likely to provide an accurate guide to how your business will actually perform. This means that you should produce three different operating budgets: one that reflects a best-case scenario, one that reflects worst-case, and one that straddles the line between the two. (Don’t worry, once you’ve created a budget with one set of numbers, it’s really easy to tweak to examine other scenarios.)
Constructing multiple budgets in this way can be a huge help in seeing how changes in key metrics from employee compensation to the price you charge for your products can affect your bottom line.
Once you’ve completed your operating budget you’ll have a set of projections not just for your total revenues and expenses for the coming year, but a predictor of the amount of profit or loss that you’re likely to earn under each of your three scenarios. Of course, if you just file the budget away and forget about it until next year it’s not going to do you all that much good. Instead, make sure to review the budget on a regular basis—at least quarterly and ideally monthly—to see how your business is tracking and to make adjustments if necessary.
While a well-constructed operating budget can help you manage your profitability, it won’t tell you much about your business’s lifeline: its cash flow. So next week we’ll explore how to create a cash-flow budget that does just that.
So, 2012 is finito. It’s over. We survived.
Let’s get going on 2013.
What’s your plan?
As entrepreneurs, we have a big mountain to climb next year. We’re facing another serious increase in costs in 2013 and some major regulations that will take time and expense to comply with.
If you run an already successful business, you are facing the abolishment or the curtailing of the limits we can write-off on equipment, technology and building improvements. This is known as the Section 179 deduction. It will result in our spending money on these things ONLY if necessary, not proactively like prosperity (and the Bush Tax Law) encouraged us to do.
We can also expect to face a limitation on the deductibility of gifts to registered tax-exempt entities like our church, local service organizations, charities, my old schools that did so much for my global understanding of the world, and many charitable donations we give that our team recommends to me such as student funding, special tournaments, the local little league and so many more. I think we would try to keep our small gifts consistent even if they were not tax advantaged, but the major gifts that support the bigger projects will have to be trimmed back, maybe by as much as 50%. “Non-Profit America” will feel this severely, unfortunately.
One of the great benefits of the Bush Tax Law was the provision which allows the company to pay the health insurance premiums for the team and write it off 100% while the employee is not charged tax on the “gift”. In 2014, that’s going to change too, which means that your employees will now pay a tax on the health insurance you give them. This is a brand new tax on the middle class, not a tax increase.
So what’s your plan for 2013?
How are you going to get up that mountain the best way, risking more if you have to, to be on top this time next year?
Here are my suggestions:
The BEST way to survive the coming economic crisis is to make more money. There are only two factors in that equation, you can bring in more or you can spend less. I would begin NOW to assess every expense you made last year and every income source to maximize BOTH sides of the equation right away, in January.
Does your company receive a large Franchise Tax bill from the state of Delaware every year? Perhaps your company has more authorized shares than what it actually needs.
The state of Delaware bases the Franchise Tax bill on the total number of shares a company has authorized, so if your company has a significant amount of authorized shares, then you may be receiving a Franchise Tax notice that could give you sticker shock.
Here is the formula for how the state of Delaware calculates the amounts due under the Authorized Shares Method:
A corporation with 10,005 authorized shares pays $225.00 ($150.00 plus $75.00)
A corporation with 100,000 authorized shares pays $825.00 ($150.00 plus $675.00[$75.00 x 9])
A corporation with 1,000,000 authorized shares pays $7575.00 ($150.00 plus $7425.00 [$75.00 x 99])
As you can see, the Franchise Tax Fees are higher when a company has more authorized shares. Of course, you also have the option to file under the alternative method, which is called the Assumed Par Value Capital Method. This method uses a formula that takes into account the relationship between the authorized shares, issued shares, par value, gross assets, et al. Typically the amount of Franchise Tax Fees due under this alternative method are less than the amount due using the original method; however, this is not always the case. Additionally, using the alternative method requires you to provide all of these internal pieces of company information to the state of Delaware every year.
So is there an alternative option? Well, if your company currently has a large number of authorized shares, maybe the shares are no longer necessary. Perhaps the initial goal was to attract a large number of investors, which unfortunately did not happen. In situations where the current number of authorized shares is no longer effective for your company, consider filing a stock change amendment.
A stock change amendment is a document filed with the state of Delaware in order to modify the total number of shares a company has authorized. If your company currently has too many authorized shares and you do not want to keep receiving potentially outrageous annual Franchise Tax notices, then filing a stock change amendment may be a viable option for you.
By filing a stock change amendment, you can reduce your company’s total authorized shares to a minimum amount. For example, a company with only 1000 authorized shares currently pays a flat Franchise Tax Fee of only $125 per year ($75 Franchise Tax plus the $50 report fee). Who wouldn’t want to pay less of an annual fee each year? In addition, it would be less hassle than having to provide several internal company details and trying to calculate the amount of the Franchise Tax Fee each year.
Harvard Business Services, Inc. can help you file a stock change amendment. Simply contact our office and we will provide further information on how to proceed.
With the seemingly interminable election cycle finally behind us, all eyes in the nation’s capital are now fixed upon the rapidly approaching fiscal cliff—the package of automatic tax increases and spending cuts that will hit the economy in January unless Congress can agree on a new deficit-reduction plan.
While most Washington watchers seem to think that the two parties will strike some sort of compromise that will stop us from going over the cliff—and sending the economy back into a recession—most also agree that certain taxes are likely to rise as soon as next year. And while that’s not the type of cheery holiday news small-business owners would like to hear, there are several things that we can do between now and the end of the year to help soften the blow of any lumps of coal that the taxman may deliver.
Let’s start by looking at end-of-year bonuses. While most companies conduct their employee reviews and announce any bonuses during November and December, many don’t actually pay those bonuses until January or February. If your company falls into that group, you might want to reconsider and pay those bonuses before the year is up.
Because whatever the outcome in Washington, it looks like the payroll tax holiday that we’ve enjoyed for the past few years could expire in January. If it does, then the payroll contribution that employees make to Social Security will rise form 4.2% to 6.2% of wages, meaning that paying bonuses this year instead of next will allow recipients—yourself included—to keep more of that bonus check for themselves. Put another way, it means that you can effectively give your workers a bigger after-tax bonus this year (as opposed to next) without paying them an additional dime.
In addition to payroll taxes going up, expectations seem to be growing that taxes on capital gains and dividends may increase as well. The capital gains rate could rise from 15% to 20% and the dividend rate from 15% to as much 43.4% depending on your tax bracket.
In addition to speaking with you financial advisor about how to mitigate any negative effects these changes could have on your investment portfolio, you should also consider strategies for minimizing their impact on your business.
If you are looking to dispose of any company assets at a profit and can do so before year end, you can lock in the current 15% capital gains rate. And if you regularly pay yourself and other key officers with distributions that are treated as dividends for tax purposes, there may be some serious cost savings associated with paying those out before 2012 comes to a close.
Some companies with lots of cash on hand are even declaring special dividends this year in order to give owners a return on their capital at the currently advantageous rate. But before you go raiding the company coffers, make sure that you can afford to do so and that it makes sense for the long-term health of your business. And take some time to consult with your tax advisor to ascertain which strategies can help your firm steer clear of that fiscal cliff no matter what happens in Washington.
As a small-business owner you are no doubt comfortable going it alone, making big decisions, and probably don’t have a problem embracing the “fake it till you make it” philosophy for getting ahead. Still, even the savviest entrepreneurs can sometimes benefit from a little expert help from those who have previously blazed a successful trail in their industry. But where are you supposed to turn for guidance when you’re the one steering the ship?
Finding a mentor with relevant experience who can help your business get on the right track or take it to the next level can be extremely valuable for many entrepreneurs. Mentors can supply hand-tailored advice, share industry best practices, and provide real-world examples that helped them succeed. And fortunately there are lots of free and low-cost mentorship opportunities available from both public- and private-sector organizations. Let’s take a look at a few of them.
SCORE is a non-profit partner of the U.S. Small Business Administration that provides free and low-cost advice and mentoring to new entrepreneurs as well as existing small-business owners. Anyone that owns a business or is planning to start one can take advantage of SCORE’s services, which range from one-on-one meetings with mentors to online workshops, as well as a host of tools and templates to assist with business planning, financial projections, and accounting. They have over 350 offices around the country, and in addition to its free mentoring services SCORE also offers low-cost workshops and seminars.
While SCORE has been around for nearly 50 years, the Entrepreneurial Mentor Corps was launched just last year as part of Startup America's initiative. This program is focused on providing mentoring services to companies with a high potential for growth and has a goal of connecting 1,000 early-stage companies with mentors who can help them achieve that growth potential. The program’s first phase is focused on the clean-tech sector, but there are plans to expand it to a variety of industries so keep abreast of what they are up to if you’d like to participate.
In addition to the aforementioned organizations operating in the public and non-profit sectors, a number of entrepreneurs are finding help from a source normally more associated with outsize profits than small-business philanthropy: Wall Street investment banks. A number of these firms, including UBS, Bank of America, Citigroup, JP Morgan Chase, and Goldman Sachs, currently have programs that pair small-business owners with finance and business experts that work for the banks. These programs tend to focus on established firms looking to expand their business as opposed to start ups looking to get off the ground.
With all of the bad press that Wall Street has gotten recently it would be easy to dismiss these efforts as little more than a publicity stunt. And while the banks certainly do have a vested interest in the outcome—a successful businessperson is an attractive potential customer—some entrepreneurs seem happy with the results. Clothing designer Alicia Estrada had this to say of her experience with UBS, “It’s teaching business owners how to fish, instead of just giving them a fish.”
So whatever stage your company is at, there are mentors out there who are available and willing to help. And if you’ve already navigated the road to success and want to help others follow in your footsteps, you might consider becoming a mentor yourself. If you’ve had a positive experience, feel free to share it here with the HBS community.