I want to start a cabinet/wood furniture business, but I would have to invest a lot of money in the machinery. Do you think I should wait for the economy to rebound?
If you want to start a business, you certainly need to obtain the assets in the form of equipment in order to do so. Without assets, you simply cannot operate.
Fortunately, when you purchase assets, you are stimulating the economy. The legislators understand purchases help not only the business owner, but also the economy in general. Therefore, there are provisions within the Internal Revenue Code that are intended to motivate capital investment by businesses. These provisions allow business owners to write-off (deduct) a large portion of the purchase price against their current-year income.
How is this a benefit? The concept of “matching” in accounting dictates expenses must be taken in the period that they helped generate the revenue. For example, if you prepay rent for two years, you would expense half the rent over year one and half over year two. If this is not done, the financial statements will not measure the results of operations fairly.
The legislators, however, allow deviation from the traditional “matching” requirement to allow for a larger write-off in the year of purchase. In turn, this lowers taxable income and the corresponding tax liability. The “magic” code section which allows this is Section 179.
Section 179 of the Internal Revenue Code allows businesses to potentially deduct the full purchase price, up to $134,000 in 2010, of qualifying equipment, whether purchased or financed, during the tax year. To prevent abuse by purchasing “too much” within a single year, the deduction does phase out if the total annual purchases exceed $530,000. Often, this ceiling does not affect business owners; however, in the case of a start-up business where many purchases are necessary, this $530,000 total purchase limit may become a concern.
Keep in mind, even though Section 179 will allow a business owner to reduce tax, taking advantage of this write-off through purchasing equipment only makes sound business sense if the equipment is needed. Too often as professionals we hear of business owners purchasing unneeded equipment with the motivating factor being to “write it off.” Of course, they do receive a write-off, but spending $1 on equipment to save 25 cents in tax is not a sound business decision.
But, in this case, the equipment is necessary to start the business. Taking advantage of Section 179 will accelerate the deductions and lead to lower income taxes. This helps keep cash in the business.
How does a business owner create an accounting plan to actually make a profit?
Though the implementation of engineering for profit is detailed and requires expertise, developing a framework in business really does not have to be overcomplicated. No singular “magic silver bullet” provides the overall fix for achieving profit. However, devising a strategic plan for profit provides a secure starting block for a business owner. Following the basic framework for goal setting can provide guidance in designing a plan for profit.
When one wants to achieve a goal, the likelihood of success is significantly multiplied when four principles are applied.
- The goal should be reasonable;
- The progress and end result must be measurable;
- A written plan of attack is utilized; and
- A distinct time limit exists.
Goal-setting principles can be utilized in achieving a profit in the business.
Measuring a goal
In a weight loss plan, individuals are encouraged to weigh in on a timely basis. Without the objective system of measurement (weight), an individual would not know how close he/she is to meeting his/her ideal weight. He/she would not know if further diet, exercise or other lifestyle changes were necessary. Similarly, absent an adequate system of measurement, how would he/she ever know if the company was profitable? Before addressing how to accomplish these goals, a business owner must learn how to track these goals. Amazingly, cash flow and profit are covered specifically in two of the three basic financial statements depended upon by accountants, financial analysts and investors, for example. These individuals use financial statements to manage and gauge a business’ “health.”
Together with the balance sheet, a statement of cash flows and an income statement (with its alias “profit and loss statement”) should be used by a business owner to make both day-to-day and long-term decisions within the business. Without the use of these statements, a business owner is no different than a pilot trying to fly an aircraft without an instrument panel satiated with gauges (the airplane’s “dashboard”). How much fuel is remaining? At what altitude are we flying? Where are we headed? Is the landing gear out? How do I adjust my flight according to the information I have? Without gauges in the cockpit of a business, an owner is simply flying by the seat of his/her pants!
Setting a reasonable target
“Without goals and plans to reach them, you are like a ship that has set sail with no destination.” (Fitzhugh Dodson)
Next, a business owner must try to set a goal (budget/benchmark) for this profit. Without a measurable, reasonable target, a business owner is also like a ship without a port—not entirely controlling the direction of his/her business. When considering financial goals within a business, looking at historic financials, analyzing “best-case scenarios” and comparing industry data may provide direction. Furthermore, a professional opinion to objectively examine the business and the industry may provide guidance in a timely manner. The sooner a goal is set, the sooner the ship can set sail to meet the destination. (In other words, the sooner ownership can begin to engineer the business towards a specific, measurable profit.)
With specific regard to profitability, changing the way in which profit is contemplated may further aid in determining the level of profit. In traditional business teaching, revenue (also known as sales) must exceed expenses within a given period of time. Traditional accounting teaches the following:
- Revenue – variable expenses = gross profit
- Gross profit – fixed expenses = net profit
- Net profit – taxes = after-tax profit
What does this mean? Simply, some expenses change in dollar amount with revenue (variable expenses, like materials for an assembly line—the more you sell, the more you need). Other expenses remain relatively stable regardless of the level of revenue (fixed expenses, like rent—no matter how much you sell, your rent will probably remain the same).
The flaw in learning revenue – expenses = profit is the implication of profit being an uncontrollable afterthought of the business. This insinuates profit is merely the “leftovers” of the business, similar to the “leftovers” after dinner—the profit is what no one else wanted!
The secret to generating a profit is to control the costs of the business. To the surprise of business owners, even tax can be a controllable expense through the use of proper expertise, systems and controls. Further, business owners must break free from traditional notions of profit being the “leftovers” of the business. Rather, a business owner must actually design for a profit from the start.
Ideally, the owner should BEGIN with the amount of desired (and reasonable) profit and figure what is allowable expense based on their amount of historic revenue. Although the equation could be much more in-depth, keep the following in mind: After-tax profit = revenue – variable expenses – fixed expenses – taxes. In order to reach the desired profit, the owner must implement the systems to control their costs, including tax, and maintain these systems within their business, using their dashboard of gauges (financial statements) to make adjustments, when necessary.
Implement a written plan of attack
“A good plan is like a roadmap: it shows a final destination and the best way to get there.” (H. Stanley Judd)
Written goals hold people more accountable. (They are more difficult to alter.) Implementing a plan of attack will increase the likelihood of success. Some tools in the plan may include not only a positive goal statement, but also tools such as budgets.
When goals do not have defined ends, procrastination can poison their successful achievement. “The best diet is the diet that starts tomorrow” has not proven to be a successful weight loss tactic. Conversely, setting a goal time, tracking progress on a periodic basis and having a plan of attack have proven to be successful strategies when trying to lose weight (i.e., Weight Watchers). The best diet starts immediately, tracks and has a defined goal date.
Creating sub-goals within the overall plan allows for greater probability of reaching a goal. Determining the correct timeline in which an owner may provide himself/herself or key employees with a report card is necessary in achieving the end result.
Logically, a goal without an ending does not help a business owner create the proper sub-goals (or “stepping stones”) to reach the goal. Without a defined ending, how can one budget to meet the goal?
Though creating a plan for profit, together with the proper reporting system by which to measure progress, does not in itself create profit, these tasks will put an owner closer to the desired end result. Without an architectural drawing and tools of measurement, how would a contractor ever build a house?