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7 Financial Facts To Know About Your Business
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Article 7: Managing Earnings And Distributions
Determining profit and loss for your business is a relatively simple process, detailed earlier in our discussion of the profit and loss statement. The next step is determining what to do with the profits your business earns.
“One of the most important things small-business owners must learn is how to manage the earnings from their companies,” says Lisa Aldisert, a management consultant who specializes in small business financial management and growth. “The key is to devise a strategy for proactively managing your earnings — both for the financial health of your company and to meet your long-term personal goals.”
Aldisert lists the following questions you should ask in devising your earnings management strategy:
Do the needs of your business require reinvesting earnings back into the company? If not, should you still keep earnings in the business, or create a distribution for yourself? How do you handle the timing of paying for large expenses? How does your plan tie into your long-term personal financial strategy?
“Managing earnings is largely tax-driven,” says Aldisert, “and there can be distinct strategies based on your legal structure. Also, if you have cyclical or seasonal cash flow, you’ll need to account for timing.”
The economic environment makes a difference, too. “When the economy is strong, your strategy may differ from what you’d do during a slow economy,” says Aldisert.
You must determine for yourself what constitutes “excess” cash — whether it’s everything above one month’s worth of expenses, or any amount above a minimum level for working capital. “This is based largely on the seasonal and cyclical aspects of your cash flow,” says Aldisert.
A common earnings management strategy is simply to “zero out” your cash at the end of your fiscal year by distributing excess earnings to yourself. This can also be done quarterly if your cash flow is predictable, notes Aldisert.
“Small-business owners are unique in that their business is usually the cornerstone of their personal wealth, so you need to consider the impact on your personal financial strategy.”
Poor earnings management is one of the biggest reasons for the failure of fast-growing businesses, says John Barrickman, the president of New Horizons Financial Group, a consulting group specializing in small business lending.
“Owners focus on top-line sales growth and assume that as long as sales are growing, they’re successful and can take money out of the business. But when companies are growing, most profits need to go back into the business to support that growth,” often leaving little for owner distributions.
The worst thing you can do is to have no plan for earnings and distributions and just take money out of the business willy-nilly. “Managing earnings should be discussed in detail with your CPA or other tax professional,” Aldisert urges. “They are experts in what you can do to maximize cash flow, minimize tax liabilities and return the highest amount to you as the owner.”
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7 Financial Facts To Know About Your Business
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