Category Archives: Business Management

Understanding how taxes factor into an M&A transaction

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Merger and acquisition activity has been brisk in recent years. If your business is considering merging with or acquiring another business, it’s important to understand how the transaction will be taxed under current law.

Stocks vs. assets

From a tax standpoint, a transaction can basically be structured in two ways:

1. Stock (or ownership interest). A buyer can directly purchase a seller’s ownership interest if the target business is operated as a C or S corporation, a partnership, or a limited liability company (LLC) that’s treated as a partnership for tax purposes.

The now-permanent 21% corporate federal income tax rate under the Tax Cuts and Jobs Act (TCJA) makes buying the stock of a C corporation somewhat more attractive. Reasons: The corporation will pay less tax and generate more after-tax income. Plus, any built-in gains from appreciated corporate assets will be taxed at a lower rate when they’re eventually sold.

The TCJA’s reduced individual federal tax rates may also make ownership interests in S corporations, partnerships and LLCs more attractive. Reason: The passed-through income from these entities also will be taxed at lower rates on a buyer’s personal tax return. However, the TCJA’s individual rate cuts are scheduled to expire at the end of 2025, and, depending on future changes in Washington, they could be eliminated earlier or extended.

2. Assets. A buyer can also purchase the assets of a business. This may happen if a buyer only wants specific assets or product lines. And it’s the only option if the target business is a sole proprietorship or a single-member LLC that’s treated as a sole proprietorship for tax purposes.

Note: In some circumstances, a corporate stock purchase can be treated as an asset purchase by making a “Section 338 election.” Ask your tax advisor for details.

Buyer vs. seller preferences 

For several reasons, buyers usually prefer to purchase assets rather than ownership interests. Generally, a buyer’s main objective is to generate enough cash flow from an acquired business to pay any acquisition debt and provide an acceptable return on the investment. Therefore, buyers are concerned about limiting exposure to undisclosed and unknown liabilities and minimizing taxes after the deal closes.

A buyer can step up (increase) the tax basis of purchased assets to reflect the purchase price. Stepped-up basis lowers taxable gains when certain assets, such as receivables and inventory, are sold or converted into cash. It also increases depreciation and amortization deductions for qualifying assets.

Meanwhile, sellers generally prefer stock sales for tax and nontax reasons. One of their main objectives is to minimize the tax bill from a sale. That can usually be achieved by selling their ownership interests in a business (corporate stock or partnership or LLC interests) as opposed to selling business assets.

With a sale of stock or other ownership interest, liabilities generally transfer to the buyer and any gain on sale is generally treated as lower-taxed long-term capital gain (assuming the ownership interest has been held for more than one year).

Keep in mind that other issues, such as employee benefits, can also cause unexpected tax issues when merging with, or acquiring, a business.

Professional advice is critical

Buying or selling a business may be the most important transaction you make during your lifetime, so it’s important to seek professional tax advice as you negotiate. After a deal is done, it may be too late to get the best tax results. Contact us for the best way to proceed in your situation. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Be vigilant about your business credit score

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As an individual, you’ve no doubt been urged to regularly check your credit score. Most people nowadays know that, with a subpar personal credit score, they’ll have trouble buying a home or car, or just getting a reasonable-rate credit card.

But how about your business credit score? It’s important for much the same reason — you’ll have difficulty obtaining financing or procuring the assets you need to operate competitively without a solid score. So, you’ve got to be vigilant about it.

Algorithms and data

Business credit scores come from various reporting agencies, such as Experian, Equifax and Dun & Bradstreet. Each agency has its own algorithm for calculating credit scores. Like personal credit scores, higher business credit scores equate with lower risk (and vice versa).

Credit agencies track your business by its employer identification number (EIN). They compile data from your EIN, including the company’s address, phone number, owners’ names and industry classification code. Agencies may also search the Internet and public records for bankruptcies, judgments and tax liens. Suppliers, landlords, leasing companies and other creditors may also report payment experiences with the company to credit agencies.

Important factors

Timely bill payment is the biggest factor affecting your business credit score. But other important ones include:

Level of success. Higher net worth or annual revenues generally increase your credit score.

Structure. Corporations and limited liability companies tend to receive higher scores than sole proprietorships and partnerships because these entities’ financial identities are separate from those of their owners.

Industry. Some agencies keep track of the percentage of companies under the company’s industry classification code that have filed for bankruptcy. Participation in high-risk industries tends to lower a business credit score.

Track record. Credit agencies also look at the length and frequency of your company’s credit history. Once you establish credit, your business should periodically borrow additional money and then repay it on time to avoid the risk of being downgraded.

Best practices

Business credit scores help lenders decide whether to approve your loan request, as well as the loan’s interest rate, duration and other terms. Unfortunately, some small businesses and start-ups may have little to no credit history.

Build your company’s credit history by applying for a company credit card and paying the balance off each month. Also put utilities and leases in your company’s name, so the business is on the radar of the credit reporting agencies.

Sometimes, credit agencies base their ratings on incomplete, false or outdated information. Monitor your credit score regularly and note any downgrades. In some cases, the agency may be willing to change your score if you contact them and successfully prove that a rating is inaccurate.

Central role

Maintaining a healthy business credit score should play a central role in how you manage your company’s finances. Contact us for help in using credit to help maintain your cash flow and build the bottom line. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Litigation Support

5 ways to prevent fraud in your law firm

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Because they foster a collegial, trusting environment, law firms can be more vulnerable to fraud than many other types of businesses. Enforcing internal controls may simply seem unnecessary in an office of professionals dedicated to the law. Unfortunately, occupational thieves can take advantage of such complacency.

A law firm’s accounting department — payroll and accounts payable and receivable — may be particularly vulnerable. To protect against financial losses and possible public embarrassment, implement and enforce five basic controls:

1. Screen employees. Require all prospective employees, regardless of level, to complete an employment application with written authorization permitting your firm to verify information provided. Then, call references and conduct background checks (or hire a service to do it). These checks search criminal and court records, pull applicants’ credit reports and driving records, and verify their Social Security numbers.

2. Use fraud-resistant documents. The design of financial documents can help ensure proper authorization of transactions, completeness of transaction histories and adherence to other control elements. For example, use prenumbered payment vouchers that a designated partner must approve.

3. Require authorization. Authorization procedures can help prevent transactions from occurring without proper approval. In the example above, the designated partner is the authorizing party. This control is effective because the partner is in a position to know what the transactions are and how they pertain to your firm’s clients. Similarly, restrict access by maintaining current signature cards at your bank and by protecting accounting and billing systems with difficult passwords.

4. Segregate duties. Some smaller firms assign the same person to open mail, make bank deposits, record book entries and reconcile monthly bank statements. In this environment, fraud’s not only possible — it’s likely. It’s critical that your firm distribute these tasks to two or more people.

5. Provide independent oversight. A designated partner should open all bank statements. Even if the partner doesn’t review every item individually, employees will get the message that transactions will be verified. Someone outside the accounting department, such as your firm’s CPA, might also review transactions as they’re processed and financial statements at the close of accounting cycle reconciliations.

Even if your firm is like family — especially if your firm is like family — you need to reduce fraud opportunities by strengthening internal controls. If you aren’t sure if your policies are adequate, or if you’ve experienced a fraud incident, contact us at 205-345-9898 or [email protected].

© 2019 CovenantCPA

An implementation plan is key to making strategic goals a reality

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In the broadest sense, strategic planning comprises two primary tasks: establishing goals and achieving them. Many business owners would probably say the first part, coming up with objectives, is relatively easy. It’s that second part — accomplishing those goals — that can really challenge a company. The key to turning your strategic objectives into a reality is a solid implementation plan.

Start with people

After clearly identifying short- and long-range goals under a viable strategic planning process, you need to establish a formal plan for carrying it out. The most important aspect of this plan is getting the right people involved.

First, appoint an implementation leader and give him or her the authority, responsibility and accountability to communicate and champion your stated objectives. (If yours is a smaller business, you could oversee implementation yourself.)

Next, establish teams of carefully selected employees with specific duties and timelines under which to complete goal-related projects. Choose employees with the experience, will and energy to implement the plan. These teams should deliver regular progress reports to you and the implementation leader.

Watch out for roadblocks

On the surface, these steps may seem logical and foolproof. But let’s delve into what could go wrong with such a clearly defined process.

One typical problem arises when an implementation team is composed of employees wholly or largely from one department. Often, they’ll (inadvertently or intentionally) execute an objective in such a way that mostly benefits their department but ultimately hinders the company from meeting the intended goal.

To avoid this, create teams with a diversity of employees from across various departments. For example, an objective related to expanding your company’s customer base will naturally need to include members of the sales and marketing departments. But also invite administrative, production and IT staff to ensure the team’s actions are operationally practical and sustainable.

Another common roadblock is running into money problems. Ensure your implementation plan is feasible based on your company’s budget, revenue projections, and local and national economic forecasts. Ask teams to include expense reports and financial projections in their regular reports. If you determine that you can’t (or shouldn’t) implement the plan as written, don’t hesitate to revise or eliminate some goals.

Succeed at the important part

Strategic planning may seem to be “all about the ideas,” but implementing the specific goals related to your strategic plan is really the most important part of the process. Of course, it’s also the most difficult and most affected by outside forces. We can help you assess the financial feasibility of your objectives and design an implementation plan with the highest odds of success. Call or email us today 205-345-9898, [email protected].

© 2019 CovenantCPA

5 ways to give your sales staff the support they really need

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“I could sell water to a whale.”

Indeed, most salespeople possess an abundance of confidence. One could say it’s a prerequisite for the job. Because of their remarkable self-assurance, sales staffers might appear to be largely autonomous. Hand them something to sell, tell them a bit about it and let them do their thing — right?

Not necessarily. The sales department needs support just like any other part of a company. And we’re not just talking about office supplies and working phone lines. Here are five ways that your business can give its sales staff the support they really need:

1. Show them the data. Virtually every aspect of business is driven by analytics these days, but sales has been all about the data for decades. To keep up with the competition, provide your sales team with the most cutting-edge metrics. The right ones vary depending on your industry and customer base, but consider analytics such as lead conversion rate and quote-to-close.

2. Invest in sales training and upskilling. If you don’t train salespeople properly, they’ll face an uphill climb to success and may not stick around to get there with you. (This is often partly why sales staffs tend to have high turnover.) Once a salesperson is trained, offer continuing education — now commonly referred to as “upskilling” — to continue to enhance his or her talents.

3. Effectively evaluate employee performance. For sales staff, annual job reviews can boil down to a numbers game whereby it was either a good year or a bad one. Make sure your performance evaluations for salespeople are as comprehensive and productive as they are for any other type of employee. Sales goals should obviously play a role, but look for other professional development objectives as well.

4. Promote positivity, ethics and high morale. Sales is often a frustrating grind. It’s not uncommon for sales staff members to fall prey to negativity. This can manifest itself in various ways: bad interactions with customers, plummeting morale and, in worst cases, even unethical or fraudulent activities. Urge your supervisors to interact regularly with salespeople to combat pessimism and find ways to keep spirits high.

5. Regularly re-evaluate your compensation model. Finding the right way to compensate sales staff has challenged, if not perplexed, companies for years. Some businesses opt for commission only, others provide a salary plus commission. There are additional options as well, such as profit margin plans that compensate salespeople based on how well the company is doing.

If your compensation model is working well, you may not want to rock the boat. But re-evaluate its efficacy at least annually and don’t hesitate to explore other approaches. Our firm can help you analyze the numbers related to compensation as well as the metrics you’re using to track and assess sales. Call or email us! 205-345-9898 or [email protected].

© 2019 CovenantCPA

Is return fraud cutting into your store’s profits?

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For brick-and-mortar retailers, return fraud can be a serious financial threat. There are several types of schemes. But when they’re successful, they all end the same way: Stores issue refunds that they shouldn’t have. Here’s what to look for and how to limit losses.

Myriad schemes

Return fraud perpetrators could be customers, employees or even a criminal gang working with employee accomplices. In perhaps the most common scheme, an individual steals merchandise, and then returns it and insists on a cash refund, despite the lack of a receipt. Or a criminal steals merchandise from one retailer and then returns it to another for a cash refund.

Some thieves do supply receipts — but they’re fake. The “customer” hands over an altered or completely counterfeit receipt that the original payment was made in cash. The retailer then issues a full cash refund.

Other return fraud schemes might involve:

Stolen cards. The thief makes a purchase using a stolen credit card. He or she then returns the merchandise, usually on the same day (before the actual cardholder disputes the charge). The goal is a full cash refund.

Damaged goods. Instead of returning merchandise in new, as-sold condition, customers return items that are worn, damaged or broken. They distract the employee processing the refund from closely scrutinizing the merchandise with conversation or other diversions.

Crooked workers. An employee discounts merchandise and sells it to an accomplice who subsequently returns it to the same employee for a refund at full price. Workers might also steal merchandise and then instruct their accomplices to return it without a receipt for a cash refund.

Reducing crime

You can reduce the incidence of return fraud by making it hard for thieves to get their hands on cash. Issue refunds only when they’re accompanied by an original receipt and only to credit cards. Scan receipts into your point of sale system to ensure they were produced by your store’s registers. If a purchase wasn’t made with a credit card — or if the customer doesn’t have the card on hand — refund it with a store credit. You may also want to ask the customer to produce identification.

To help limit employee-perpetrated return fraud, install security cameras, ensure strong management oversight and provide a confidential fraud reporting hotline. In addition, monitor the frequency and value of returns processed by individual cashiers and investigate employees with higher-than-average return numbers.

Walking a thin line

Although you don’t want to encourage crooks, you may think a generous return policy is essential to providing superior customer service. So that you don’t alienate legitimate customers, state your return policies clearly at every cash register and on every receipt. And contact us for help writing a policy that balances all your priorities. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Using knowledge management to develop your succession plan

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As the old saying goes, “Knowledge is power.” This certainly rings true in business, as those who best understand their industries and markets tend to have a knack for staying on top. If that person is a company’s owner, however, great knowledge can turn into a vulnerability when he or she decides to retire or otherwise leave the business.

As you develop your succession plan, consider how to mitigate the loss of pure know-how that will occur when you step down. One way to tackle this risk is to implement a knowledge management strategy.

Two types of knowledge

Knowledge management is a formal process of recognizing and treating knowledge as an asset that your company can identify, maintain and share. Generally, a business can subdivide knowledge into two types:

1. Explicit knowledge. This exists in the tangible world and typically includes company reports, financial statements and databases. These items are usually easy to access, extrapolate from and append. For your succession plan, however, you may need to dig deeper into your own confidential files, memos or emails.

2. Tacit knowledge. This is information that resides solely between the ears of a business’s leadership, employees and perhaps even service providers. As such, it’s not easily retrievable. In terms of succession planning, this may be the stuff that you haven’t written down or even talked about much.

Typical categories

Typical knowledge management categories include:

  • Taxes and accounting,
  • Financial management,
  • Strategic planning,
  • HR, payroll and employment practices,
  • Sales and marketing,
  • Customers,
  • Production, and
  • Technology.

In addition, knowledge management should account for your company’s intellectual property — trade secrets, for example. Many business owners keep such details close to their vests and even managers may not know the full value of the company’s intellectual property. This could put your business at risk following your departure.

A comprehensive knowledge management effort related to your succession plan will call on you to undertake a full inventory of every category listed above and perhaps others. Gathering your explicit knowledge may entail compiling years’, even decades’, worth of documents, files and writings. This may not be an easy task, but it’s still a matter of straight research.

You’ll likely find capturing your tacit knowledge somewhat more challenging. One idea is to ask a suitable employee or engage an outside consultant to interview you regarding all the pertinent categories. Many business owners find these conversations arduous at first but eventually enlightening and enjoyable.

A legacy preserved

A solid succession plan is imperative to maintaining the future stability and success of your company. Knowledge management can strengthen that plan and help preserve the legacy you’ve worked so hard to build. Contact us for further information and for help identifying knowledge related to your tax filings, accounting methods and other financial matters. 205-345-9898 or [email protected].

© 2019 CovenantCPA

Are your employees ignoring their 401(k)s?

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For many businesses, offering employees a 401(k) plan is no longer an option — it’s a competitive necessity. But employees often grow so accustomed to having a 401(k) that they don’t pay much attention to it.

It’s in your best interest as a business owner to buck this trend. Keeping your employees engaged with their 401(k)s will increase the likelihood that they’ll appreciate this benefit and get the most from it. In turn, they’ll value you more as an employer, which can pay dividends in productivity and retention.

Promote positive awareness

Throughout the year, remind employees that a 401(k) remains one of the most tax-efficient ways to save for retirement. Regardless of investment results, the pretax advantage and any employer match make a 401(k) plan an ideal way to save.

For example, point out that, for every $100 of pay they defer to the 401(k), the entire $100 is invested in the plan — not reduced for taxes as it would be if it were paid directly to them. And any employer match increases investment potential.

At the same time, make sure employees know that your 401(k) plan operates under federal regulations. Although the value of their accounts may go up and down, it isn’t affected by the performance of your business, because plan assets aren’t commingled with company funds.

Encourage patience, involvement

The fluctuations and complexities of the stock market may cause some participants to worry about their 401(k)s — or to try not to think about them. Regularly reinforce that their accounts are part of a long-term retirement savings and investment strategy. Explain that both the economy and stock market are cyclical. If employees are invested appropriately for their respective ages, their accounts will likely rebound from most losses.

If a change occurs in the investment environment, such as a sudden drop in the stock market, present it as an opportunity for them to reassess their investment strategy and asset allocation. Market shifts have a significant impact on many individuals’ asset allocations, resulting in portfolios that may be inappropriate for their ages, retirement horizons and risk tolerance. Suggest that employees conduct annual rebalancing to maintain appropriate investment risk.

Offer help

As part of their benefits package, some businesses provide financial counseling services to employees. If you’re one of them, now is a good time to remind them of this resource. Employee assistance programs sometimes offer financial counseling as well.

Another option is to occasionally engage investment advisors to come in and meet with your employees. Your plan vendor may offer this service. Of course, you should never directly give financial advice to employees through anyone who works for your company.

Advocate appreciation

A 401(k) plan is a substantial investment for any company in time, money and resources. Encourage employees to appreciate your efforts — for their benefit and yours. We can help you assess and express the financial advantages of your plan. Call us at 205-345-9898 or email us at [email protected].

© 2019 CovenantCPA

Preventing phoenix companies from taking flight with your money

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Bankruptcy (or liquidation) can be a valid business tool when used properly. Unfortunately, it can also enable less-than-honest business owners to profit at the expense of their creditors. Such is often the case with “phoenix” companies.

Rising from the ashes

Phoenix companies earn their name because they rise from the ashes of failed companies, trading on the goodwill of the original businesses. Here’s how a phoenix company scheme might work: A company’s owner buys goods on credit, purposely drives the business into the ground and then buys its assets back from liquidators at knockdown prices. The owner then returns to the same line of business. Some operators repeat the process multiple times — as often as they can get away with it.

These shady companies usually are undercapitalized from the start, and they almost always leave a trail of unpaid debts to mark the end of their short life spans. Unfortunately, unsuspecting creditors may sell goods to the new company (that retains the old name) under the impression they’re dealing with the original business. Meanwhile, creditors of the original company remain unpaid.

Legitimate or not

It’s perfectly legal for an insolvent company to sell its assets to another party at market value. It’s also legal to sell a business to existing management. How, then, do you know whether a company’s decision to sell assets is made in good faith or is an effort to avoid liability? And how can you prove that a bankrupt company unable to satisfy creditors has actually funneled assets into a new business?

Forensic accounting experts investigate the owner’s background and the company’s history, taking industry into consideration. (Phoenix companies are more common in such sectors as construction and hospitality.) And they look for red flags — for example, evidence that the owner of the defunct company deliberately ran up debts before declaring bankruptcy or made selective payments to creditors that later went on to supply the new entity.

Don’t become a victim

To avoid becoming a creditor of a fraudulently bankrupt company, watch whom you do business with. Before extending credit, ask for references and verify that the customer has a record of paying its bills. Contact us for advice and help at 205-345-9898 or [email protected].

© 2019 CovenantCPA

Don’t let scope creep ruin your next IT project

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Today’s business technology is both powerful and restive. No matter how “feature rich” a software solution or hardware asset may be, there’s always another upgrade around the corner. In other words, it’s just a matter of time before your company’s next IT project.

When that day arrives, watch out for “scope creep.” This term refers to the tendency of a project’s objective (or “scope”) to gradually expand while the job is underway. As a result, the schedule may drag and dollars may go to waste.

Common culprits

A variety of things can cause scope creep. In many cases, too few users give input during the planning stage. Or misunderstandings may occur between the project team and users, obscuring the purpose of the job.

Excessive implementation time undoes many projects as well. As weeks and months go by, business processes, policies and priorities tend to change. For a new system to meet the needs of the business, the project’s scope needs to be executable within a reasonable time frame.

Ineffective project management is another common culprit. Scope creep often arises when a project manager underestimates the complexity of the tasks at hand or fails to adequately motivate his or her team.

5 steps to success

To stop or at least minimize scope creep, follow these five steps:

1. Distinguish “must-haves” from “nice-to-haves.” Draw a red line between the functionalities your business absolutely must have and any added features that would be nice to have. Schedule the prioritized requirements in the form of phased deliverables during the project’s life cycle. Add “nice-to-haves” to the final phase or, better yet, defer them to future projects.

2. Put agreed-on deliverables in writing. Use a Statement of Work document to clearly outline the stated project requirements. Be sure to cover both those that are included and those that aren’t. Have everyone involved sign off on this document.

3. Divide and conquer. Segregate the project into small, manageable phases. As it proceeds, continue to review and sign off on each phase as it’s delivered, following an adequate testing period.

4. Introduce a formal change management process. If someone demands a change, ask him or her to rationalize the request in writing on a change order form. Then analyze the potential impact, estimate the added cost and time, and obtain consensus before proceeding. Adhering to this step typically eliminates many low-priority demands.

5. Anticipate some scope creep. It’s a rare project, if any, that proceeds exactly as planned. Allow for some scope creep in your budget and timeline.

Head-on approach

Improving your company’s technology should be cause for excitement and, eventually, celebration. Unfortunately, it too often brings anxiety and conflict. Tackling scope creep head on can help ensure that your IT projects go more smoothly. Our firm can help you assess the financial impact of any technology solution you’re considering and, if you decide to proceed, set a budget for the job. Contact us at 205-345-9898 or [email protected]

© 2019 Covenant CPA