Tag: business

How to Value Your Business

This overview can help you understand the approaches, methods and factors important to valuing your business

How to Value Your BusinessRevenue Ruling 59-60 was issued by the IRS to “outline and review in general the approach, methods and factors to be considered in valuing the shares of the capital stock of closely held corporations for estate and gift tax purposes.”  This revenue ruling is regarded as the foundation of modern business valuation, and although issued sixty years ago, the approach, methods and factors set forth therein are still used in every business valuation, including valuations of business entities other than corporations.

Revenue Ruling 59-60 lists the following eight fundamental factors that require careful analysis in each case.

  1. The nature of the business and the history of the enterprise from its inception.
  2. The economic outlook in general and the condition and outlook of the specific industry in particular.
  3. The book value of the stock and the financial condition of the business.
  4. The earning capacity of the company.
  5. The dividend paying capacity.
  6. Whether or not the enterprise has goodwill or other intangible value.
  7. Sales of the stock and the size of the block to be valued.
  8. The market price of stocks of corporations involved in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over the counter.

Approaches to valuing a business

The three basic approaches in valuing a business are the asset approach, the income approach, and the market approach.  The factors listed above include the analysis required to value a business under each of these approaches.

Asset approach

Under the asset approach, the value of the business is the value of the net tangible assets.  This method does not consider goodwill or other intangible assets and is most commonly used in the valuation of real estate entities.  This method may also be applicable to unprofitable businesses and those in or close to liquidation.

Market approach

The market approach consists of two methods, the guideline public company method and transaction method.  Under the guideline public company method, the financial attributes of the subject company including but not limited to sales, earnings, cash flow, total assets, net book value are compared to the same attributes of publicly traded companies in the same or similar industries, and with fairly complex analysis, the value of the subject company is determined by comparison to the stock price of the publicly traded company.  This method is generally not applicable to small businesses because they are not usually comparable to publicly traded companies, even those in the same industry.

Under the transaction method, the value of the subject company is determined based on analysis of and comparison to the financial attributes of similar companies that have sold in private transactions.  This method is used when there are enough comparable transactions, and enough financial information about these transactions is available.

Income approach

Under the income approach, a measure of income (generally normalized cash flow) is capitalized or discounted to estimate the value of the company.  Capitalization is used for historical cash flow; discounting is used for projected cash flow.  The capitalization rate is based on risk, that is, the risk that the expected cash flow will not be realized.  Common closely held business risks considered in this process include customer or supplier concentration or diversification, depth of the management team, product obsolescence, prospective competition, and the state of the industry in which the company participates.

Learning more about business valuation

This is a ten-thousand-foot view of business valuation.  Future posts will provide detailed information of things discussed here.  Many of the factors considered are controllable, and factors reducing business value can often be improved.  Those who are considering the future sale of a business and want to maximize its value should start thinking about this now.  If you wait until you are ready to sell, that is usually too late.  The first step is to understand the current value of the business, and what are the factors driving that value.  After that, the valuation can be periodically updated, which will be a gauge of progress in increasing value.

Visit our business valuation page to learn more about our business valuation services and  contact us if you want to discuss planning the future of your business.

Use the Increased Federal Estate and Gift Tax Exemption to Transfer Business Ownership Interests

Take advantage of this window of opportunity for tax-free wealth transfer

Use the Increased Federal Estate and Gift Tax Exemption to Transfer Business Ownership InterestsThe Tax Cuts and Jobs Act of 2017 expanded the federal estate and gift tax exemption to $11.2 million per person, or $22.4 million for a married couple.

Under the Act, these higher limits are applicable through December 31, 2025.  On January 1, 2026 the limits return to $5 million per person, adjusted for inflation.

These changes present a significant but temporary opportunity for tax-free wealth transfer, including gifts of ownership interests in the family business.  Also, in certain circumstances valuation discounts may further reduce the value of the gifted business interest, which would facilitate larger gifts while remaining within the exemption amount.  These gifts will also qualify for the annual exclusion, which currently stands at $14,000 per recipient and may also be split with your spouse, resulting in $28,000 per recipient annual gifts that do not reduce your lifetime exemption.

Gifting strategies

Business owners are often reluctant to gift business ownership interests because they are concerned about losing control of the business, or do not want to make gifts to minor children.   There are many ways to overcome this problem.  The most common solutions are to gift only non-voting shares and include restrictions on their sale or transfer, or to gift the shares to a trust of which you or your spouse are trustee.

Conventional gifting strategy is to transfer assets that are likely to appreciate in the future.  That way, the asset is transferred at a low value and appreciates in the hands of the recipient.  The first step in this process is to identify the assets to be transferred and determine their value.  If you are considering transfer of an ownership interest in a business, it would be prudent to have that business valued by a qualified business appraiser.

We’ve got your back

Although 2025 seems like a long way off, you never know what changes may occur.  Although it is unlikely that tax laws will change after the mid-term election, you never know what the tax law changes will be after the 2020 presidential election.  This is great opportunity to transfer assets at little or no estate and gift tax cost.  If this is interesting to you, there is no reason to delay.  Contact your attorney or CPA and start the process now, before this opportunity is gone.

Capital Gains and Losses: How Do They Work?

Selling a capital asset results in a gain or loss and impacts your income taxes.

How do capital gains and losses work?A capital gain is a profit made when you as an individual or business sell a capital asset — investments or real estate, for instance — for a higher cost than its purchase price. A capital loss is incurred when there’s a decrease in the capital asset value compared with its purchase price. Almost everything you own and use for personal or investment purposes is a capital asset: a home, personal-use items like furnishings, and collectibles.

A capital gain may be short term (one year or less) or long term (more than a year). The capital gain must be claimed on income taxes. While capital gains are generally associated with stocks and mutual funds due to their volatility, a capital gain can occur on any security sold for a higher price than the price that was paid for it. Unrealized gains and losses, sometimes referred to as paper gains and losses, reflect an increase or decrease in an investment’s value but haven’t yet triggered a taxable event.

The profit you realize when you sell a capital asset at a profit is your gain over basis paid. Basis is often defined as the original price plus any related transaction costs; basis also may refer to capital improvements and cost of sale. Capital losses are used to offset capital gains of the same type: short-term losses are deducted against short-term gains, for example.

Capital gains and losses for businesses

A business may gain or lose money in two ways: It can make a profit on its sales activities or lose money by spending more than it brings in from sales. And, of course, it can gain or lose money based on its investments or sales of assets — items of value that the business owns.

Each type is taxed differently. Profits are taxed as ordinary income and at regular business or personal tax rates. Gains or losses on investments or the sale of assets are taxed as capital gains or losses, but it can depend on the type of business. When expensive equipment is involved, businesses have to consider depreciation, which takes into account the equipment’s declining value over its useful lifetime.

Capital gains and losses can come into play when a business writes off an asset, taking it off its balance sheet. That might be the case with accounts receivable when a debt is owed to the business but is unlikely ever to be paid.

Individual shareholders or business owners who sell their capital shares or owner’s equity in a business also incur capital gains or losses from those sales. Note the following distinction: Operating profits and losses result from the ongoing operations of the business; sometimes called net operating losses for tax purposes, they result from day-to-day operations.

We’ve got your back

Whether you’re buying or selling as an individual or as a business, be sure to keep track of your sales and discuss them with a qualified financial professional. The experts at KRS can help you determine whether you have a gain on loss and its tax implications. Contact managing partner Maria Rollins at [email protected] or 201.655.7411 for a complimentary initial consultation.

Why Business Succession Planning Is Important

Why Business Succession Planning is ImportantYour business represents a big part of your wealth. Here’s why you need to protect it with a succession plan.

Many years ago, I had a friend who was a financial advisor and specialized in estate planning.  In encouraging people to establish or update their planning, he would tell them that not having a plan was the same as having a plan to leave extra money to the IRS, to the detriment of their intended heirs.  The same goes for business succession planning.  Not having a succession plan doesn’t mean that you will never retire or die, it just means that when you do there will most likely be a dispute and a judge or mediator will decide what happens to your business.

Wouldn’t it be much better if you established a plan for your business?

There are many reasons why a business succession plan is important.  For many business owners, the business represents most or a significant portion of their wealth.  Whether the plan is to keep the business in the family, sell to employees, or sell to an outsider, a written plan will play a big part in a smooth transition, which will preserve the value of your business.

A transition plan will also help you prepare for any unplanned circumstances, such as death, disability, or inability to work.  When something bad happens, it is usually too late to execute an effective plan.

Preparing next gen leaders

If the business is being kept in the family or sold to employees, a succession plan will go a long way in preparing the management team or next generation to take over the business.  This process must commence long before the transition begins to be successful.

Finally, an effective plan will help you focus on the value of your business and the steps that you can take to increase that value.  Many owners are unrealistic about the value of their business, believing that value is simply a multiple of something, the amount they put into the business, or an uninformed guess.  The value of a business is based on future cash flow and risk.  Good cash flow and low risk translates into high value.  What can you do today to increase the value of your business?

We’ve got your back

If you’re ready to plan for business succession but don’t know where to start, contact me at [email protected].

Audits, Reviews and Compilations: A Summary

Which financial statement overview you need from your CPA depends on your business and financing needs

Audits, Reviews and Compilations: A SummaryYou will want to prepare your financial statements in accordance with an accounting framework that’s appropriate for your business. Most of the time, you’ll opt for a CPA to produce your financial statements. Getting an accountant’s blessing is especially useful when you are applying for more credit from a bank.

Financial statements are intended to give you current information on your business’s financial standing so you can make more informed decisions. There are three levels of overview you can choose to take — compilation, review or audit — and what you select will have a lot to do with what your objective is.

The Compilation

According to guidance from the American Institute of CPAs, a compilation is suitable for use by lenders and other outside parties who may appreciate the business’s association with a CPA. There is no assurance here, but the CPA will read the financial statements in light of the financial reporting framework being used and consider whether the financial statements appear appropriate in form and are free from obvious material misstatements.

It may be appropriate when a company is seeking only relatively minor levels of financing and may have significant collateral.

The Review

The next level is a review. According to the AICPA, the review is designed to provide lenders and other outside parties with a basic level of assurance on the accuracy of financial statements. The CPA performs analytical procedures, inquiries and other procedures to obtain limited assurance on the financial statements to provide a user with a level of comfort on their accuracy.

A review might be the right move for companies seeking larger levels of financing and have more complex credit needs.

The Audit

The highest level of assurance is an audit. The CPA performs procedures to obtain “reasonable assurance” (defined as a high but not absolute level of assurance) about whether the financial statements are free from material misstatement, according to the AICPA. The CPA is required to obtain an understanding of your business’s internal control and to assess fraud risk. Your CPA is also required to corroborate the amounts and disclosures included in your financial statements by obtaining audit evidence through inquiry, physical inspection, observation, third-party confirmations, examination, analytical procedures and other procedures.

An audit is an annual requirement for publicly held companies and may be advisable for other companies seeking high levels of finance and opening themselves to outside investors.

Required Frequency

How often will you want your CPA to peruse your finances? Overviews can be done in any frequency that is useful to you and your business — monthly, quarterly or annually. Some folks say that your financial statements are more than snapshots of your business but can be seen as resources to tell you where your risks and opportunities are. Financial statements can help you identify and solve potential problems before they compromise the health of your business.

We’ve got your back

Rather than guessing at audit, reviews and compilations, why not let the experts at KRS CPAs help? Learn more about our accounting and assurance services, then contact managing partner Maria Rollins at [email protected] or 201.655.7411 for a complimentary initial consultation.

Put Your Children on Your Payroll and Reduce Taxes

One tax reduction strategy that most business owners do not take advantage of is putting their childrenPutting Your Children on Your Payroll on payroll.

This can help reduce the overall family tax bill and transfer assets to children without introducing gift tax implications.

As a business owner, you can deduct wages paid to children, while the child can offset those wages with their own standard deduction.  In addition to the standard deduction, you could setup pre-tax retirement accounts that would allow taxpayers to deduct more, while the child saves for retirement.

For partnerships and disregarded entities, if your child is under 18, the company does not have to pay employment taxes such as Social Security, Medicare and Workers’ Compensation Insurance. You can also avoid Unemployment taxes until the child turns 21. But for S-Corps and C-Corps, Social Security and Medicare taxes are paid regardless of age. These payroll taxes amount to 15.3% of wages earned, your share and child’s share.

Potential tax savings

With that in mind, let’s review a sample of potential tax savings. Starting in 2019, the standard deduction is $12,000 for single filers. The maximum contribution to a traditional IRA is $6,000 (if modified adjusted gross income is less than $64,000 for single filers in 2019). Additionally, taxpayers can draft a 401(k) plan that includes no age limitations, which will allow younger children to contribute $19,000 of pre-tax dollars to their 401(k). The example below illustrates the potential tax savings if the taxpayer’s entity is an S-Corporation.

Save taxes by putting your children on your payrollIf the entity is an LLC instead of an S-Corp, and your child is under 18, add back the payroll taxes of $5,585 to get your tax saving potential.

One other benefit you could produce is a safe harbor 401(k) plan or profit sharing/matching system that could increase your child’s retirement account and provides a deduction for your business. This strategy has plenty of scenarios to take into consideration which provide an opportunity to save even more money in taxes.

There are some rules you need to be aware of when using this strategy:

  • Keeping detailed employment records, including timely tracking of weekly hours and wages that correspond to services provided
  • Issuing paychecks as you would a normal employee (e.g., bi-weekly)
  • Documenting that the services are legitimate and considered ordinary and necessary for the business
  • Ensuring the services provided do not include typical household chores

If your child is not treated like any other employee in a similar position, the IRS could potentially deem their wages as not ordinary and necessary, and disallow them as a deductible expense.

We’ve got your back

At KRS, our CPAs can help you strategize setting your children up on payroll to maximize potential tax savings. Give us a call at 201.655.7411 or email me at [email protected]

Should Rules of Thumb Be Used to Value a Business?

Should Rules of Thumb Be Used to Value a Business?I frequently receive requests to quickly value a business by applying a “rule of thumb”, that is, application of a simple formula to the gross or net income of a business to determine its value.  The value of a business is based on two factors: cash flow and risk.  Using a rule of thumb to value a business considers neither.

Rules of thumb are old wives’ tales of business valuation; no one knows where they come from or the basis upon which they were derived.

How rules of thumb get it wrong

As a simple example, consider two hypothetical businesses in the same industry (Company A and Company B).  Each has $2 million of sales and $400,000 net income.  Using a rule of thumb would result in both businesses having the same value.  But what if all of Company A’s sales came from a single customer, and Company B’s sales consisted of $100,000 each to twenty customers.  Which company is more valuable?  Company A clearly has more risk because the loss of a single customer would put it out of business.  However, this factor, and many similar factors, are never considered by rules of thumb.

In determining what they will pay for a business, investors consider projected cash flow and risk that projected cash flow will not be realized.  A fair market value buyer pays for cash flow; the greater the cash flow the more the buyer will pay.  Cash flow includes funds available for distribution during the period of ownership, as well as the amount received upon the sale of the business.  The cash flow is discounted at a rate based on risk; the greater the risk the higher the discount rate and the lower the business value.

Risks to consider

Risks common to many businesses include customer and/or supplier concentration, competition, lack of management depth, and product obsolescence.  This list is not all inclusive as most businesses are unique and may face other risks not mentioned.

We’ve got your back

Estimating the value of a business requires thorough analysis of the business, the industry, the marketplace, and the economy.   If you want to know the value of a business, don’t use a rule of thumb; engage a business valuation professional.  You will be glad you did.

Now Is the Time for Business Succession Planning

According to several national surveys of closely held business owners, approximately three in five do not have any business succession plan in place.

At KRS, we specialize in advising owners of family and closely held businesses and our observations are consistent with the survey results.Now is the time for business succession planning

I am working with Joe, the owner of a profitable $75 million company, and we have been talking about succession planning for several years.  Joe is in his mid-sixties, in good health, and has no plan to retire in the foreseeable future.   Are you surprised that Joe has no succession plan for his business? Like many business owners, Joe can’t get his arms around the fact that having a plan doesn’t make retirement mandatory; it only protects the business (which is Joe’s most valuable asset) if he does.   Although we frequently discuss the importance of succession planning, Joe doesn’t seem to want to face the tough decisions involved.

Employee and customer concerns

Joe’s employees have been concerned about succession plans for quite a while.  When I met with him recently, Joe shared the fact that several of his major customers have also asked about his plans for the company.  Joe said that the customers don’t want to see the plan and don’t care about the financial arrangements, but they just want to know that the company will continue if something happens to Joe.  They want to know who will run the company if Joe can’t.  This is understandable, especially since the company is a major supplier for several customers.  The customers don’t want to risk interruption in product supply and they may reduce this risk by diversifying purchases among several suppliers if they don’t get answers, resulting in decreased revenue and profitability for Joe’s company.

Plan succession before it’s too late

Joe is the sole owner of his company, but succession planning is equally important in multiple owner companies.  In all cases, it is best to execute a plan while everyone is healthy and getting along.  When a triggering event occurs, it is usually too late.  If you are a business owner, review your succession plan today, and if you don’t have a plan, contact your attorney and CPA to start working on one.

Time to Send Out Those 1099-Misc Forms

Time to Send Out Those 1099-Misc FormsWith tax season right around the corner, it’s time to start thinking about closing your books out for the year and preparing all your tax documents.

One of the required tax documents you may need to send out is the 1099-Misc. While this can be a tedious task, especially if you haven’t kept good records on your independent contractors, it is necessary to avoid penalties by the IRS. To help simplify things, here are the basics:

As a general rule, you must issue a Form 1099-Misc to each person to whom you have paid at least $600 in rents, services (included parts and materials), prizes and awards, or other income payments. You don’t need to issue 1099-Misc for payments made for personal purposes.  You are required to issue 1099-Misc to report payments you made in the course of your trade or business. You’ll send this form to any individual, partnership, Limited Liability Company, Limited Partnership, or estate.

Some 1099 exceptions

There is a lengthy list of exceptions, but the most common one is payments to corporation. All payments made to a corporation do not typically require a 1099-Misc.  This means that if you make payments to a company that is incorporated or to an LLC that elects to be treated as a C-Corporation or S-Corporation, then this would not be reported on a 1099-Misc.  Unfortunately, this exception doesn’t apply to payments you made to an attorney.

Another exception is payments to vendors using a credit card or through a third-party payment network. You are not required to send a 1099-Misc for amounts paid electronically.  Instead, the credit card companies and payment companies will handle any required reporting.  Those electronic payment providers are required under certain circumstances to send out a different version of the 1099-Misc, called the 1099-K, instead.

Get those W-9s from vendors

To make the 1099 process easier, it is best practice for business owners to request a Form W-9 from any vendor you expect to pay more than $600 before you pay them.  Form W-9 will give you the vendor’s mailing information, Tax ID number, and also require the vendor to indicate if it is a corporation or not.  Having a completed W-9 will give you all the information to complete the 1099-Misc and save you a lot of headaches during tax season.

For the current year’s payments, businesses must send 1099-MISC to the recipients by January 31 of the following year.  Businesses also must send copies of each 1099-MISC sent to recipients to the IRS.  The deadline to the IRS is January 31.  This deadline applies to Form 1099-MISC when reporting non-employee compensation payment in Box 7.  Otherwise, paper filings must be filed with the IRS by February 28 and electronic filing by March 31. Also depending on the state law, businesses may also have to file the 1099s with the state.

We have your back

Rather than guessing at the IRS rules and requirements, why not let the KRS CPAs tax experts help? We will help you organize Form 1099 MISC recipient data and prepare all the necessary forms for you to submit. Contact Kelley DaCunha at [email protected] to get started.

Using Financial Reports to Manage Your Business

Your financial reports can be far more useful than just a report on the state of your business.

You can use these reports to manage your business, diagnosis what’s going right and wrong, and set goals for how to grow and add to your bottom line.

What are financial reports?

Financial reports are issued at set intervals and go to shareholders, partners, investors, and potential lenders.Using Financial Reports to Manage Your Business They describe your company’s financial strengths and weaknesses and typically contain the following:

  • Balance sheet: includes statement of liabilities, assets, and business capital
  • Income statement: reports on a company’s financial performance, how it gets revenue, and how and incurs expenses
  • Cash flow statement: shows how the changes in the balance sheet affect cash and cash equivalents that flow in and out of the company

Clearly, these financial statements are essential to run your company on financial fact, not hopes and prayers. Keeping these records thoroughly is the first step in running a successful business, being prepared at tax time to pay the IRS, and accurately valuing your company should you decide to sell. Any lender or investor will want to see your financial report before deciding whether they want to hitch their money to your star.

Why GAAP is a smart move

Although some companies generate their own financial statements, many turn to their accountant to formalize their statements according to GAAP, Generally Accepted Accounting Principles. It’s a smart move; here’s why:

  • Accountants can present your numbers so they are easy to read and understand.
  • If you’re a public company, accountants can provide audited financials that are certified by an independent entity.
  • Accountants can professionally format your numbers, give the statement a fancy cover, and state that an independent accountant has accepted your numbers.

Hidden gold in financial statements

Financial statements are a great tool to help you answer questions about your company and to manage money and priorities. At a glance, these statements can help you determine critical expenses as well as evaluate whether your financial position is getting better or worse, whether your staff is contributing enough to the bottom line, and whether you’re meeting set benchmarks.

We’ve got your back

We can help you compile and analyze your financial statements. Rather than guessing at financial statements, why not let the experts at KRS CPAs help? Contact us at 201.655.7411 for a complimentary initial consultation.