With 2019 winding down, now is the time to forecast 2020 and 2021 business goals, whether that is consolidating short-term, high-interest debt, partner buy-out, expansion into different revenue channels or cashflow management. Sit down with your key employees, board members and your CPA to create a financial forecast to strategize upcoming needs. Here are some critical small business tax tips to consider during your tax planning and forecasting discussions.
If you are anticipating approaching a bank for financing, discuss your goals with your CPA and be open about considering future debt. Why? We all try to avoid paying unreasonable taxes as much as possible. Often owners are given advice to stockpile inventory, purchase equipment, pre-pay expenses and so on at year-end so that their tax burden decreases. While that absolutely makes sense, showing a lack of profit the year before approaching a financial institution can create challenges.
If you paid for large onetime expenses out of business cash flow, like fermentation capacity or software, keep that documentation to show your CPA and the bank. It is helpful for the banker to understand large onetime expenses that were paid from company cash flow. Although we can see an increase of inventory and supplies on the balance sheet, the profitability of the business looks poor. Bankers look for profitability to determine financing eligibility and business health.
A few non-cash expenses that CPAs can use to reduce your tax burden are interest, depreciation and amortization. These are considered “add-backs” to the net income. Essentially, a financial institution likes to see profitability before addbacks. After the addbacks are taken into consideration, the business will look much stronger. Joshua Lance, founder of Lance CPA Group, suggests “With any capital purchases, make sure you strategize the best way to depreciate those assets from a tax perspective. Making a poor choice upfront could have negative tax consequences in the future.”
It is important to have a CPA that is familiar with a manufacturing business, as they will be able to take advantage of tax breaks craft producers receive. Wade Huseth, a partner at Baker Tilly Virchow Krause, LLP weighs in, “Cash planning can be a challenge for brewers, particularly if the cash outflows do not result in any tax benefit. Two good uses of cash in the current tax environment are production expansion and research and development (R&D). Current tax law allows for 100% depreciation in the year of a new equipment purchase, meaning a full deduction for the cost to increase capacity or add a canning line, for example. Brewers may not be aware that the labor and supplies used to craft new recipes are eligible for R&D credits. These credits are useful because they can be used to offset payroll taxes in the event that the company is currently operating at a tax loss. Utilizing your cash in tax-favorable ways can alleviate the stress of high tax liabilities and the uncertainty of how you are going to pay come tax time.”
Be cognizant of distributions to shareholders. Distribution is money that is leaving the business. If possible, leave this cash on the balance sheet so the financial institution can see the ability to save money and have access to liquidity.
Discuss your tax burden and feel comfortable that you can pay your taxes in full or create a payment plan. An outstanding tax burden will be considered in a lender’s financial analysis. If you have a large tax repayment plan and minimal cash liquidity on the balance sheet, that is cause for concern. Tax liens are frequently a deal killer.
Profitability is important as this shows the ability to repay a loan. No one enjoys paying taxes, but if you anticipate seeking debt in 2020 or 2021, talk to your CPA sooner rather than later so you can plan appropriately. As a seasoned lender to the beverage industry, I know it typically takes a year to become profitable. I am also aware that it takes great foresight to increase profitability year over year. Ultimately, you must prove that the business can repay the loan. I focus a lot on year-over-year financial trends, as well as profitability based upon tax returns and interim financials. It is challenging to lend on interims and projections alone. Lenders rely on filed tax returns during financial analysis.
Huseth suggests “As the year comes to a close and you’re reviewing the financial performance of your business, start to think about what areas you can improve in 2020 when it comes to your financial management and reporting. Some things you may want to consider or ask yourself: Do you have a clear picture of financial performance during a given month or are you only reviewing after the fact? Are you managing your cash strategically and effectively? Are you utilizing technology to produce your reporting or are many processes still manual? As you and your team gear up for the new year, we suggest developing a standard cash flow forecast (if not already being utilized) and find ways to incorporate technology into your accounting function to help drive efficiency and take a step closer to having real-time financial data.”
Many breweries have decided to put expansion on hold due to increased competition, poor distribution partners and a crowded market. “The end goal for any growth plan is to ensure profitability in the future. Growing revenues without a look at your costs of goods sold and operating expenses could result in less profitability than you had prior to your growth plan. Revenue is vanity, profit is sanity,” states Lance. Instead, you might consider consolidating debt to free up cash flow or consider buying out non-performing equity partners.
When considering debt consolidation, the goal is to save money and free up cash flow. If the new lender cannot save you at least 10% in annual savings, then it might not be worth the expense of a new loan to refinance. Typically, an SBA loan has longer amortizations than a conventional loan. Although you may be paying a higher interest rate for a longer-term loan, the overall benefits of a consolidation loan may be appealing. Do not only focus on rate. Consider amortization term, pre-payment penalties, equity injection, collateral and loan covenants.
Partner buy-out opportunities might be the focus for this year. Are there equity partners who seem to constrain your company or no longer interested in being involved? Working with your attorney to understand the operating agreement and necessary steps to begin the conversation is a great place to start. Partner-buy out is an eligible loan request under the SBA program. Larger breweries may want to entertain the idea of an ESOP.
If you are not seeking institution financing for the upcoming year, then your CPA will take that into consideration. However, if you are contemplating debt or an equity raise, both a bank and investors will be looking at the health of the business. As you start looking ahead to 2020 and beyond, be sure to create a comprehensive tax plan and forecast strategy with key business advisors to help you achieve your goals.
As a lender for Live Oak Bank’s wine and craft beverage lending division, Kate Lumpkin has specialized in craft beverage businesses working primarily with breweries, wineries and distilleries since 2015. She understands the unique challenges that owners face and provides a straightforward lending experience to help them avoid costly mistakes and thrive. Kate works from Live Oak’s Headquarters in Wilmington, NC, but travels across the country to meet with craft beverage producers seeking expansion and advising them of their best loan options for their growing business.
Joshua Lance is the founder and managing director of Lance CPA Group, a virtual CPA firm that focuses on providing accounting and consulting services to craft breweries and digital agencies. Josh was honored by being selected to the 2017 class of the AICPA Leadership Academy and was named as one of the “40 under 40” in 2017, 2018 and 2019 by CPA Practice Advisor. Josh was recently appointed to the Illinois CPA Society Board of Directors and the AICPA PCPS Executive Committee.
Wade Huseth is a partner with Baker Tilly and has more than 26 years of experience in providing financial accounting advisory services to companies in a variety of industries. Wade also leads the firm’s client accounting services practice and specializes in leveraging best-in-class technologies and industry expertise to deliver customized accounting, finance and operational assistance to clients of all sizes.