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Whether for a day, a week or longer, many of the costs associated with business trips may be tax-deductible. The tax code includes a myriad of rules designed to prevent abuses of tax-deductible business travel. One concern is that taxpayers will disguise personal trips as business trips. However, there are times when taxpayers can include some personal activities along with business travel and not run afoul of the IRS.

Business travel

You are considered “traveling away from home” for tax purposes if your duties require you to be away from the general area of your home for a period substantially longer than an ordinary day's work, and you need sleep or rest to meet the demands of work while away. Taxpayers who travel on business may deduct travel expenses if they are not otherwise lavish or extravagant. Business travel expenses include the costs of getting to and from the business destination and any business-related expenses at that destination.

Deductible travel expenses while away from home include, but are not limited to, the costs of:

Travel by airplane, train, bus, or car to/from the business destination.
Fares for taxis or other types of transportation between the airport or train station and lodging, the lodging location and the work location, and from one customer to another, or from one place of business to another.
Meals and lodging.
Tips for services related to any of these expenses.
Dry cleaning and laundry.
Business calls while on the business trip.
Other similar ordinary and necessary expenses related to business travel.

Business mixed with personal travel

Travel that is primarily for personal reasons, such as a vacation, is a nondeductible personal expense. However, taxpayers often mix personal travel with business travel. In many cases, business travelers may able to engage in some non-business activities and not lose all of the tax benefits associated with business travel.

The primary purpose of a trip is determined by looking at the facts and circumstances of each case. An important factor is the amount of time you spent on personal activities during the trip as compared to the amount of time spent on activities directly relating to business.

Let’s look at an example. Amanda, a self-employed architect, resides in Seattle. Amanda travels on business to Denver. Her business trip lasts six days. Before departing for home, Amanda travels to Colorado Springs to visit her son, Jeffrey. Amanda’s total expenses are $1,800 for the nine days that she was away from home. If Amanda had not stopped in Colorado Springs, her trip would have been gone only six days and the total cost would have been $1,200. According to past IRS precedent, Amanda can deduct $1,200 for the trip, including the cost of round-trip transportation to and from Denver.

Weekend stayovers

Business travel often concludes on a Friday but it may be more economical to stay over Saturday night and take advantage of a lower travel fare. Generally, the costs of the weekend stayover are deductible as long as they are reasonable. Staying over a Saturday night is one way to add some personal time to a business trip.

Foreign travel

The rules for foreign travel are particularly complex. The amount of deductible travel expenses for foreign travel is linked to how much of the trip was business related. Generally, an individual can deduct all of his or her travel expenses of getting to and from the business destination if the trip is entirely for business.

In certain cases, foreign travel is considered entirely for business even if the taxpayer did not spend his or her entire time on business activities. For example, a foreign business trip is considered entirely for business if the taxpayer was outside the U.S. for more than one week and he or she spent less than 25 percent of the total time outside the U.S. on non-business activities. Other exceptions exist for business travel outside the U.S. for less than one week and in cases where the employee did not have substantial control in planning the trip.

Foreign conventions are especially difficult, but no impossible, to write off depending upon the circumstances. The taxpayer may deduct expenses incurred in attending foreign convention seminar or similar meeting only if it is directly related to active conduct of trade or business and if it is as reasonable to be held outside North American area as within North American area.

Tax home

To determine if an individual is traveling away from home on business, the first step is to determine the location of the taxpayer’s tax home. A taxpayer’s tax home is generally his or her regular place of business, regardless of where he or she maintains his or her family home. An individual may not have a regular or main place of business. In these cases, the individual’s tax home would generally be the place where he or she regularly lives. The duration of an assignment is also a factor. If an assignment or job away from the individual’s main place of work is temporary, his or her tax home does not change. Generally, a temporary assignment is one that lasts less than one year.

The distinction between tax home and family home is important, among other reasons, to determine if certain deductions are allowed. Here’s an example.

Alec’s family home is in Tucson, where he works for ABC Co. 14 weeks a year. Alec spends the remaining 38 weeks of the year working for ABC Co. in San Diego. Alec has maintained this work schedule for the past three years. While in San Diego, Alec resides in a hotel and takes most of his meals at restaurants. San Diego would be treated as Alec’s tax home because he spends most of his time there. Consequently, Alec would not be able to deduct the costs of lodging and meals in San Diego.

Accountable and nonaccountable plans

Many employees are reimbursed by their employer for business travel expenses. Depending on the type of plan the employer has, the reimbursement for business travel may or may not be taxable. There are two types of plans: accountable plans and nonaccountable plans.

An accountable plan is not taxable to the employee. Amounts paid under an accountable plan are not wages and are not subject to income tax withholding and federal employment taxes. Accountable plans have a number of requirements:

There must be a business connection to the expenditure. The expense must be a deductible business expense incurred in connection with services performed as an employee. If not reimbursed by the employer, the expense would be deductible by the employee on his or her individual income tax return.

There must be adequate accounting by the recipient within a reasonable period of time. Employees must verify the date, time, place, amount and the business purpose of the expenses.

Excess reimbursements or advances must be returned within a reasonable period of time.

Amounts paid under a nonaccountable plan are taxable to employees and are subject to all employment taxes and withholding. A plan may be labeled an accountable plan but if it fails to qualify, the IRS treats it as a nonaccountable plan. If you have any questions about accountable plans, please contact our office.

As mentioned, the tax rules for business travel are complex. Please contact our office if you have any questions.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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Almost every day brings news reports of Americans recovering from tornados, wild fires, and other natural disasters. Recovery is often a slow process and when faced with the loss of home or place of businesses, taxes are likely the last thing on a person’s mind. However, the tax code’s rules on casualty losses and disaster relief can be of significant help after a disaster.

Almost every day brings news reports of Americans recovering from tornados, wild fires, and other natural disasters. Recovery is often a slow process and when faced with the loss of home or place of businesses, taxes are likely the last thing on a person’s mind. However, the tax code’s rules on casualty losses and disaster relief can be of significant help after a disaster.

Disaster relief

Natural disasters, such as tornados and wild fires, have long been recognized as events giving rise to casualty losses. These events are characterized by their suddenness. A casualty loss must flow from an event that is sudden; it cannot be a gradual event, such as normal wear and tear.

Large scale events are frequently designated as federal disasters. This designation is important. When the federal government designates a locality a federally-declared disaster area, special tax rules about casualty losses and filing/payment deadlines apply.

Casualty losses are generally deductible in the year the casualty occurred. However, taxpayers with casualty losses in a federally-declared disaster area may treat the loss as having occurred in the year immediately prior to the tax year in which the disaster happened. This means the taxpayer can deduct the loss on his or her return for that preceding tax year and possibly generate an immediate refund.

A federal disaster declaration also authorizes the IRS postpone certain deadlines for taxpayers who reside or have a business in the disaster area. The IRS can give taxpayers extra time to file returns. The IRS also waives failure-to-deposit penalties for employment and excise tax deposits. The IRS automatically identifies taxpayers located in the disaster area and applies filing and payment relief. Affected taxpayers who reside or have a business located outside the covered disaster area must contact the IRS to request relief.

Casualty losses

To deduct a casualty loss, a taxpayer must be able to show that there was a casualty. The taxpayer also must be able to support the amount the taxpayer takes as a deduction. It is helpful to take photographs of the property as soon as possible after the disaster. These photographs can be compared to ones taken before the disaster to show the extent of the damage.

A personal casualty loss is generally subject to a $100 floor and to a 10 percent of adjusted gross income (AGI) limitation. Only one $100 floor applies to married taxpayers filing a joint return; married taxpayers filing separate returns are each subject to a $100 floor. If a casualty loss takes place within a presidentially declared disaster area, taxpayers are also given the option of filing an amended return for the year before the disaster, taking the loss on that return, and thereby qualifying for an immediate tax refund to the extent that the loss lowers tax liability. The immediate extra cash provided by the refund often helps the taxpayer rebuild quickly where insurance recovery does not cover the entire cost. While this option is usually beneficial, a particular taxpayer’s tax position may point to a greater tax savings if the casualty loss deduction is taken in the current year instead.

Special rules

Special casualty loss rules apply to business or income-producing property. Taxpayers with business or income-producing property that is completely destroyed calculate their loss by subtracting any insurance or other reimbursement they receive or expect to receive along with any salvage value from their adjusted basis in the property.

Personal-use real property is also subject to special rules. Taxpayers who suffer damage to personal property (non-real property) also must meet different criteria.

Taxpayers in certain disaster areas, such as the Gulf Opportunity (GO) Zone, may also be eligible for enhanced disaster relief. Several years ago, Congress enacted national disaster relief that provided for bonus depreciation, expanded expensing and other provisions. However, this national disaster relief has expired for most taxpayers.

If you have any questions about disaster relief, please contact our office.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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Americans donate hundreds of millions of dollars every year to charity. It is important that every donation be used as the donors intended and that the charity is legitimate. The IRS oversees the activities of charitable organizations. This is a huge job because of the number and diversity of tax-exempt organizations and one that the IRS takes very seriously.

Exempt organizations

Charitable organizations often are organized as tax-exempt entities. To be tax-exempt under Code Sec. 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes in Code Sec. 501(c)(3), and none of its earnings may inure to any private shareholder or individual. In addition, it may not be an action organization; that is, it may not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates. Churches that meet the requirements of Code Sec. 501(c)(3) are automatically considered tax exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS.

Tax-exempt organizations must file annual reports with the IRS. If an organization fails to file the required reports for three consecutive years, its tax-exempt status is automatically revoked. Recently, the tax-exempt status of more than 200,000 organizations was automatically revoked. Most of these organizations are very small ones and the IRS believes that they likely did not know about the requirement to file or risk loss of tax-exempt status. The IRS has put special procedures in place to help these small organizations regain their tax-exempt status.

Contributions

Contributions to qualified charities are tax-deductible. They key word here is qualified. The organization must be recognized by the IRS as a legitimate charity.

The IRS maintains a list of organizations eligible to receive tax-deductible charitable contributions. The list is known as Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986. Similar information is available on an IRS Business Master File (BMF) extract.

In certain cases, the IRS will allow deductions for contributions to organizations that have lost their exempt status but are listed in or covered by Publication 78 or the BMF extract. Additionally, private foundations and sponsoring organizations of donor-advised funds generally may rely on an organization's foundation status (or supporting organization type) set forth in Publication 78 or the BMF extract for grant-making purposes.

Generally, the donor must be unaware of the change in status of the organization. If the donor had knowledge of the organization’s revocation of exempt status, knew that revocation was imminent or was responsible for the loss of status, the IRS will disallow any purported deduction.

Churches

As mentioned earlier, churches are not required to apply for tax-exempt status. This means that taxpayers may claim a charitable deduction for donations to a church that meets the Code Sec. 501(c)(3) requirements even though the church has neither sought nor received IRS recognition that it is tax-exempt.

Foreign charities

Contributions to foreign charities may be deductible under an income tax treaty. For example, taxpayers may be able to deduct contributions to certain Canadian charitable organizations covered under an income tax treaty with Canada. Before donating to a foreign charity, please contact our office and we can determine if the contribution meets the IRS requirements for deductibility.

The rules governing charities, tax-exempt organizations and contributions are complex. Please contact our office if you have any questions.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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Depreciation on a business asset is calculated using an applicable method, period, and convention. To compute the deduction for the year the property is placed in service and the year the property is disposed of or retired, the tax code use averaging conventions to establish deemed placed-in-service and retirement dates. Depreciation is allowed for the portion of the tax year that the property is placed in service under the applicable convention.

Under the current depreciation system (generally applicable to tangible property placed in service after 1986), depreciation is calculated using an applicable method, period, and convention. To compute the deduction for the year the property is placed in service and the year the property is disposed of or retired, the tax code uses averaging conventions to establish deemed placed-in-service and retirement dates. Depreciation is allowed for the portion of the tax year that the property is placed in service under the applicable convention.

Under the tax code, the applicable convention generally is the half-year convention, although other conventions (mid-month or mid-quarter) may also apply. The half-year convention applies to all depreciable property other than residential rental property and nonresidential real property, unless the mid-quarter convention applies. (The mid-month convention applies to residential rental property, nonresidential real property, and certain railroad property.) The mid-quarter convention is used in place of the half-year convention if more than 40 percent of the cost of property (other than real property) is placed in service in the last quarter of the tax year.

The convention applies to the first year and the last year of depreciation. Property that is placed in service after the beginning of the tax year is entitled to six months of depreciation. The property is also entitled to six months of depreciation in the year of disposal or in the year that the useful life expires (as if the property were sold at the mid-point of the tax year). The averaging convention must be followed consistently for an asset account.

Depreciation under the half-year convention is calculated by treating all property as if it were placed in service on the first day of the second half of the tax year (July 1 for a calendar year taxpayer), the midpoint of the tax year. Similarly, property that is retired during the year is treated as retired on the first day of the second half of the tax year. The amount of depreciation in a tax year when the half-year convention applies is one-half the amount that would be allowed by taking depreciation for the full tax year.

Example. A calendar year taxpayer purchases a machine on January 1 and begins to use it on February 1, The applicable convention determines the placed-in-service date and the calculation of depreciation. Under the half-year convention, the machine is deemed to be placed in service on July 1, even though it was actually placed in service on February 1. The taxpayer can take six months of depreciation for the period July 1 to December 31 of the first year. If property previously placed in service were retired on February 1 (and the property had not been fully depreciated), the property would be treated as disposed of on June 30, and the taxpayer could take six months of depreciation.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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With school out for the summer, parents are looking for activities for their children. The possibilities include sending a child to day camp or overnight camp. Parents may wonder whether these costs are deductible. At least two possible tax breaks come to mind: the dependent care credit, and the deduction for medical expenses. The most likely tax benefit is the child (or dependent) care credit.

Dependent care credit. To qualify for the dependent care credit, expenses must be employment-related. They must enable the parent to work or to look for employment. The IRS has indicated that the costs of sending a child to overnight camp are not employment-related. However, the costs of sending a child to day camp are treated like day-care costs and will qualify as employment-related expenses (even if the camp features educational activities). At the same time, the costs of sending a child to summer school or to a tutor are not employment-related and cannot be deducted.

In some situations, the IRS requires that expenses be allocated between child care and other, nonqualified services. However, the full cost of day camp generally qualifies for the dependent care credit, without an allocation being required. If the parent works part-time, camp costs may only be claimed for the days worked. However, if the camp requires that the child be enrolled for the entire week, then the full cost is qualified.

Example. Tom works Monday through Wednesday and sends his child to day camp for the entire week. The camp charges $50 per day and children do not have to enroll for an entire week. Tom can only claim $150 in expenses. However, if the camp requires that the child be enrolled for the entire week, Tom can claim $250 in expenses.

Dependent care costs also may be reimbursed by a flexible spending account (FSAs) under an employer-sponsored arrangement. FSAs allow pre-tax dollars to fund the account up to specified maximum. Each FSA may limit what it covers so check with your employer before assuming the day camp or similar child care is on its list of reimbursable expenses.

Medical expenses. The cost of camp generally is not deductible as a medical expense. The cost of providing general care to a healthy child is a nondeductible personal expense.

Example. The child’s mother works; the child’s father is ill and cannot take care of the child. The cost of sending the child to summer camp is not deductible as a medical expense; however, the costs may still qualify for the dependent care credit.

However, camps specifically run for handicapped children and operated to assist the child may come under the umbrella of medical expenses. The degree of assistance is usually determinative in these situations.

Dependency exemption. In any case, the cost of sending a child to camp can be treated as support, for claiming a dependency exemption. For a parent to claim a dependency exemption, the child cannot provide more than half of its own support. The parent must provide some support but does not necessarily have to provide over half of the child’s support. If the child is treated as a qualifying relative (because he or she is too old to be a qualifying child), the parent must still provide over half of the child’s support.

The rules on the deductibility of camp costs are somewhat complicated, especially in borderline situations. Please check with this office if you have any questions.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of July 2011.

July 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 25-28.

July 7

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 29-30, July 1.

July 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 2-5.

July 11

Employees who work for tips. Employees who received $20 or more in tips during June must report them to their employer using Form 4070.

July 13

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 6-8.

July 15

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 9-12.

Monthly depositors. Monthly depositors must deposit employment taxes for payments in June.

July 20

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 13-15.

July 22

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 16-19.

July 27

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 20-22.

July 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 23-25.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

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by Charles Bosler, CPA, MBA, ABV

Only one out of three large businesses put on the block during 2001 actually sold. For smaller businesses, the statistics are less favorable. Only 1 out of 5.5, or 18% sold. What about the sole proprietor not having employees and therefore not included in the above statistics? Their equipment and ongoing customer list is undoubtedly worth something to another competitor. The agreed upon value, however, is most always dependent upon the buyer’s later success in retaining those customers. The reality is, your business might provide you with a decent livlihood for much of your career. But unless your business has the attributes in place which appeal to not just one but many likely buyers, do not bank a comfortable retirement upon the liklihood of selling to just the one, required buyer who fully appreciates your opinion of its fair market value.

What exactly is it that business buyers are looking for? This question should be important to business owners long before moving on to other pursuits.

No one finds out what it takes to successfully compete in today’s world more thoroughly than the business owner. Public servants do not, as public money will roll in tomorrow to fund their existence regardless of how efficient their decisions are today. Corporate employees do not, as their piece of the big picture is rarely as big as the business owner’s, and only their income is at stake based on their performance, not so much on their reputation and significant amounts of their invested capital.

We all know that we have to compete once reaching the age of reason, but few have to excel in as many areas as the business owner. Areas which must be mastered include sales and marketing, operating at top efficiency, technological advancement as it applies to all aspects of the business, human relations, billing, collections, and other organizational disciplines. The business owner must be especially good in most all of these areas if he expects to grow over the long term. In order to have a chance at financial success, a business must first be headed by one or more persons who are better than average at what they do. After all, how could a business thrive very long amongst competition offering better consumer choices? Anyone succeeding over the long term in the capacity of running their own business has reason to be proud. They did it their way and must have been better than average in the effort. Otherwise, the competition would have edged them out. Indeed, most people are not up for this level of challenge to the extent they will put their financial livelihoods and that of their family’s on the line.

One would think that if he or she nurtured a business for many years and proved its ability to compete in today’s world, they should be able to count on the sale of that business for a good part of their retirement funds. Yet the following statistics taken from the 2001 Business Reference Guide and the International Business Brokers Association imply otherwise.

Number of Privately Owned Businesses with Employees that Sell
	Annual Revenues	# of Employees	Normally Priced	% of All Businesses	# of Businesses	# For Sale	# That Sell
General Business Brokerage	<$750K	<10	<$500K	80%	4,370,000	864,000 1 out of 5	157,000 1 out of 5.5
Larger Businesses	$750K-$2M	10-20	$500K-$3M	9%	590,000	173,000 1 out of 3.5	43,000 1 out of 4
Midsize Company	$2M-$30M	21-200	$3M-$20M	8%	490,000	73,000 1 out of 7	21,000 1 out of 3.5
Larger Businesses	>$30M	>100	>$20M	3%	50,000	8,000 1 out of 6	2,500 1 out of 3

Only one out of three large businesses put on the block during 2001 actually sold. For smaller businesses, the statistics are less favorable. Only 1 out of 5.5, or 18% sold. What about the sole proprietor not having employees and therefore not included in the above table? Their equipment and ongoing customer list is undoubtedly worth something to another competitor. The agreed upon value, however, is most always dependent upon the buyer’s later success in retaining those customers. The reality is, your business might provide you with a decent livlihood for much of your career. But unless your business has the attributes in place which appeal to not just one but many likely buyers, do not bank a comfortable retirement upon the liklihood of selling to just the one, required buyer who fully appreciates your opinion of its fair market value. No buyer will have your specific talents, reputation, and network. Interested prospects will estimate the future cash flow that your business will likely provide them, not you, and the many risks that may result in worse results. If their assessment of the present value of future cash flow is notably below your asking price, most will not even counter with a lower offer.

What exactly is it that business buyers are looking for? This question should be important to business owners long before moving on to other pursuits. If not addressed until late in one’s career, statistics previously shown imply that two-thirds of even the largest privately held businesses put on the block will not receive an acceptable purchase offer in a given year. For businesses having under $750,000 in annual sales, over 80% do not receive an acceptable purchase offer. What additional hoops must the business owner jump through to realize their own opinion of fair market value when it comes time to sell? With sound advice rarely present when such thoughts surface, delay is often the easier emotional choice for many entrepreneurs to make, who identify personally with their company. But with delay, the best opportunities often come and go.

The typical business owner is readily willing to work 50% or more hours per week than the average employee to maintain the company’s profitability and reputation for reliability . Early on, it might have been a lack of working capital that caused the owner to wear many hats. Once doubts about the business being a viable going concern were removed, happiness with the status quo rarely provided continued success. The successful owner had to continue changing because the world continually changed. Long term business owners are not only survivors but usually have the wits to take many along with them. Yet when it has come time to sell, only a small minority of these owners make a convincing case that their business is worth what they think it is. After surviving so many challenges, what is it they fail to do?

Like any successful institution which has survived over generations, top management at least annually should take stock of what they have accomplished, where they are now, where they want to go, and how they plan to get there. The more organized entrepreneurs often do this in the form of written minutes to an annual meeting. Take two businesses that are equal to each other at the moment, with the exception that one is stagnant and the other is moving forward with obvious positive momentum and positive developments in the pipeline. The second business will always be worth significantly more at that point in time, as much of the value of a business comes from extrapolating its future prospects. Making sure that the business has positive momentum and developments unfolding all the time should be thoroughly addressed at least annually. A written action plan for the following year, even if in checklist form, is mandatory if you want others to be able to duplicate your success.

A businessman wanting to someday receive fair market value for his business should answer the following questions at least annually:

Question Number 1. Where are we now?

Maximizing business value begins with identifying the value components and drivers of the business as they exist today. Items enumerated might include superior service, products or processes. They might include a superior marketing plan, and/or key personnel able to accomplish much more than their peers due in part to policies and equipment in place. They might include a position of financial strength and operating efficiencies resulting from past experiences of trial and error. Additional but by no means a complete set of possible attributes as to where you are at now appears in Appendix I . Whatever these value components are, their identification will help your later plan to increase value even more.

Before completing your mostly subjective analysis of where the company is at now, make sure your analysis minimally builds on the following points of interest to prospective buyers someday:

Your company’s history
Your company’s ownership
Your company’s products and services
Your company’s customers
Your company’s facilities
Make up your company’s management
Make up your company’s workforce
Your company’s suppliers
Your company’s competition

On his own behalf, the business owner should also apply himself quantitatively at least annually by monitoring those financial ratios that are most applicable to his business, also measuring financial strength and weaknesses of most interest someday to prospective buyers. Such financial ratios are most often categorized in the following areas:

Liquidity Ratios
Efficiency Ratios
Profitability Ratios
Leverage Ratios
Coverage Ratios
Other Ratios

Appendix II near the end of this article more specifically describes ratios often used by bankers and investment analysts in the above categories. You should annually note how your company has performed in relation to industry averages, which are available at many public libraries. Only after periodic review of the financial ratios most applicable in measuring the financial strength and efficiency of your business, will you more clearly understand what the outsider’s conclusions will be towards the risks, cash flow, and liklihood for internal growth to be expected from your company. Constantly striving towards continued ratio improvements is the same as striving towards a higher valuation for your business someday. If you already know that the financial analysis will be favorable before the prospective buyers do their due diligence, you will find yourself in the driver’s seat when it comes time to sell.

Question Number 2. Where do we want to be?

Most prospective buyers of a business will base their maximum offering price based upon three basic components: current cash flow, current growth prospects, and currently perceived risk factors associated with the business. Accordingly, business owners will be well rewarded later if they regularly identifies the most cost efficient alternatives available to:

increase the Company’s cash flows
increase the Company’s growth rate
decrease in the amount of risks involved in operating the business

With respect to increasing the growth rate, growth alone does not increase the value of a business. Only growth that results in additional cash flow over and above additional working capital required to comfortably accommodate that growth, will result in an increased business valuation. Less disciplined growth pursued for growth’s sake alone often decreases the value of a business. Indeed, low margin growth can and often does result in less cash flows being generated from operations.

If you want your business to be worth more in the future then it is today, you need to widen your focus no farther than towards (a) increasing its cash flows, (b) increasing its growth rate while maintaining or improving margins, and (c ) reducing the many risks associated with your business.

Question Number 3. How do we get there?

By the time you have solidified where you are now and where you want to go, you will have many ideas about the most cost efficient options available to increase your company’s value. Policies put into place should be conducive towards fostering some combination of increasing profitable growth, increasing cash flows and reducing business risks.

Increasing Growth

There are four ways for a business to grow:

More marketing to increase market share
Develop new product lines and services
Buy another business entity or product line
Merge with another business entity.

Which is the cheaper for you to do, make or buy growth? This will essentially be a capital budgeting decision which should be easy to make. Careful analysis will lead you towards the avenue is best for you. From there, you should itemize the steps to likely succeed along the chosen avenue, and put them into effect. If you don’t put the steps into writing, do not expect growth or an increased business valuation to result.

Increasing Cash Flows

Growth is not the only way to increase cash flows. The earlier suggested ratio analysis will help you evaluate how your business stacks up in comparison to competitors. Apparent inefficiencies are an obvious starting place. The world economy is always in a phase of shifting actual production to the most cost efficient suppliers. Have you evaluated all your reasonable options to reduce labor and material costs? Are you turning your receivables over at least as fast as the competition? Is your inventory tightly monitored so as to not to unnecessarily result in waste, theft, or working capital being tied up? Yet inventory availability must still be sufficient to foster growth. Are you purchasing your inventory from the most cost effective source? What about your facilities and equipment? Could it be more efficiently configured ? Is there machinery available that could replace more expensive labor? Has the business sold off its investment in unneeded facilities and equipment, allowing capital to be put to better use?

You run your own business in part because you are more creative and energetic than the next guy. You are costing yourself money if you do not put that creativity to work on your own behalf. You should always have a strategy in place with the ultimate objective of increasing cash flows from existing operations. There are consulting firms who will help you here when you run low on your own ideas.

Reduce the Risks Surrounding Your Business

Businesses which have removed many of the uncertainties about their future cash flows always sell for greater multiples of current cash flows than higher risk operations. General Electric (GE) for instance, has long established itself as being a company which hires only the best employees available. Even then they reward only the top 80% with a graduated level of job security, bonuses, other pay increases, and benefits commensurate with their performance. GE is always introducing new products and/or delving into growing markets currently earning profit margins noticeably better than more mature product lines typically yield. GE abides by a stable debt to equity ratio which has resulted in its Triple A credit rating, a standard which implies treatment of creditors with utmost respect. Basically, investors have come to expect 15% to 20% annual growth in GE’s sales and earnings, and that is most often what they later see. As large as GE is, they still sell at a price earnings ratio most always over 20, a level usually associated with smaller growth companies. One reason is because GE has consistently shown investors in the past that they can count on steadily increased cash flows in the future. It manages and handles everyday obstacles and even the review of growth opportunities in routine manner. Law suits against it are rarely reported in the financial press, as are labor problems, despite their selective hiring policies. By making its future results very predictable, GE’s management has eliminated the perception of their being much risk about its future course and cash flow path. Its management has succeeded in achieving and then maintaining the company in a rather elite class among even the largest of companies. Minimizing business risks in many different areas had to be emphasized by its Board over many years to achieve this recognition. Investors as a result have been paying a premium for its common stock for many years.

While increased value for a business may come more rapidly from profitable growth and by increasing cash flows, generating the same level of cash flows with lower risk also creates value. In assessing vulnerability to risks, not much can be done about the over all economy effecting all businesses. Nor can management readily switch into a new industry by completely changing its customer base in a short period of time. Management, however, can work towards changing the business into a better company. The following areas are often looked at first by outsiders when assessing the level of risk associated with operations:

Access to and the cost of capital
Ownership structure and stock transfer restrictions
Company’s market share and market structure of the industry
Customer concentration
Depth and breadth of management
Distribution capability
Extent of reliance on individuals with key knowledge, skills, or contacts
Workforce competitiveness, employee relations, and reliance
Marketing and advertising capacity/efficiency
Breadth of products and services
Purchasing power and related economies of scale
Customer concentration
Vendor and supplier relations and reliance
Work force competitiveness, employer relations, and reliance
Distribution capability
Depth, accuracy, and timeliness of accounting information and internal control

High rankings in all the above areas equates into low risk operations. See Appendix I for more ideas.

You are undoubtedly able to list significant risk areas surrounding your own business to work on first. What is it most that would make your business vulnerable to uncertainty in a prospective buyer’s eyes? Improve that area and a number of less time consuming or costly areas every year. Smoother operations will result. Your business will be worth more for that reason alone.

Conclusion

As illustrated near the outset, at least two-thirds of all private businesses listed for sale do not receive an acceptable purchase offer in a year’s time. The typical business owner works hard for many years and has probably proven himself financially to be all around superior to peers in capitalizing upon opportunities that surface. When it comes time to move on, is it then time to watch the business wither away, watch past momentus efforts evaporate over a short period while competitor’s take their slice for free? Or can this same competitive businessman turn periodic, slow periods thorughout the year into a time to update his notes on where he is now, where he wants to be, and how he is going to get there. If he does not address these issues well ahead of time, all the more likely he will be cast with the majority.

Up until now, you worked hard to excell amongst your peers. Why stop short when your periodically updated, written notations now mean so much towards how your future years will be lived?

Appendix I

Identifying Valuation Components, Value Drivers and Risk Reducers

Common Value Drivers

Intangibles
Well Defined Mission and Vision Statement Owner’s Particular Product/Services Knowledge Management’s Knowledge, Experience and Depth Motivated and Dependable Work Force Key Employees Bound by Non Compete Agreements Organizational Structure Promotes Efficiency Management Succession Plan in Place Active Outside Board of Directors Long History, Reputation and Name Recognition Management Focus on Growth and Value Creation Industry Regulations Impact Company Profits	Business Plan is Constantly Monitored and Updated Owner’s Personal Relationships with the Customers, etc. Loyal Customers Few Competitors Special Barriers to Competition Strong Supplier Relations Located in a Growing Geographical Market Part of a Growing Industry Reputable Company Advisors Active and Visable in Community and Industry Affairs Economic Conditions Influence Product Demand
Operating
Repeat Customers - Customer List Trained and Knowledgeable Workforce Proprietary Products: Patents, Copyrights Recognizable Trademark or Trade Name Large Market Share (size) Diversified: Products, Customers, Geographic (size Special Franchise Arrangement Exclusive Distributor/Supplier Rights Special Operating Procedures and Trade Secrets Favorable Location to Customers, Suppliers, etc. Market Intelligence Systems in Place	Brand Name Distributor Industry Specialization Special Niche Market Product/Service Differentiation is Well Defined Unique Manufacturing/Production Process Special Services: Delivery, Repair, Warranty Creative Use of Website to Sell Products or Services Strategic Partnering and Alliances Strategic Planning Processes in Place ISO 9000 Registered Vendor EOQ and Other Inventory Control Systems in Place
Investment
Commitment to Human Capital (training, benefits, etc.) State of the Art Technology Equipment Large Inventory Selection (size) On-going Investment in Information Technology	Additional Capacity for Growth (space, manpower, etc.) Well Maintained Capital Equipment Commitment to Research and Development Capital Budgeting Processes in Place
Financial
Key Management Have Incentive Compensation Plans High Margins Due to Efficiencies, etc. Strong Liquidity Position Optimal Financial Leverage Optimal Operating Leverage Favorable Tax Structure Internal Controls are Well Defined Properly Insured Against External Risks	Long-Term Profitable Customer Contracts Purchasing Power (size) Favorable Lease Terms Favorable Debt Financing Terms (size) Financing Plans in Place to Secure Needed Capital Funded Buy-Sell Agreement Budgeting System Controls Costs and Eliminate Waste Budgeting System Controls Costs and Eliminate Waste Systems in Place to Comply with Laws and Regulations

Appendix II

Financial Ratios

Memo: For Industry Averages, refer to Robert Morris' and Associates Annual Financial Statement Studies, or other credible sources maintained by many public libraries.

Liquidity Ratios Liquidity is a measure of the quality and adequacy of current assets to meet current obligations as they come due.
Ratio	Formula	Interpretation
Current Ratio	= Total Current Assets Total Current Liabilities	Rough indication of a firm's ability to service its current obligations. Higher ratios show stronger liquidity; composition, however, and quality of current assets is critical.
Quick Ratio	= Cash + Cash Equivalents +Net Receivables Total Current Liabilities	A conservative view of creditors' protection, since and prepaid items may not always be liquid. Generallyratio less than 1:1 implies dependency on inventory and other current assets to liquidate short-term debt.
Working Capital	= Current Assets – Current Liabilities	Working capital is a direct indicator of the company’s ability to grow.
Efficiency Ratios Efficiency ratios measure the ability to manage working capital, fixed capital, and overall return on invested assets.
Ratio	Formula	Interpretation
Accounts Receivable Turnover	= Credit Sales Average Accounts Receivable	Indicates the number of times it takes receivables to turn into cash per year. Attention should be paid to credit terms, billing procedures, trends, and industry average.
Accounts Receivable Collection Period	= 360 or 365 Days Accounts Receivable Turnover	Reflects average length of time from sale to cash collection.
Inventory Turnover	= Cost of Goods Sold Average Inventory	Indicates the number of times the business liquidates its inventory over a period and whether too little or too much inventory is carried.
Inventory – Days In Inventory	= 360 or 365 Days Inventory Turnover	Reflects the number of days it takes to sell the inventory.Used in conjunction with accounts receivable collection period to determine operating cycle.
Operating Cycle	= Accounts Receivable Collection Period + Days in Inventory	Indicates the length of time it takes to convert inventory to cash. If the cycle increases, more working capital is needed.
Accounts Payable Turnover	= (Cost of Goods Sold–Beginning Inventory + Ending Inventory) Average Accounts Payable	Indicates the number of turns per period of time it takes for the company to pay its trade payable. Should be compared to credit terms.
Accounts Payable – Days Outstanding	= 360 or 365 Days Accounts Payable Turnover	Same as for Accounts Payable Turnover (above), but number of days rather than the number of turns.
Assets Turnover	= Net Sales Total Assets	Indicates the turnover rate of total assets to achieve net sales. When viewed historically, the ratio indicates the effectiveness of generating sales from asset expansion.
Net Sales to Working Capital Turnover	= Net Sales Working Capital	An indication of the amount of working capital required to support sales. An increasing ratio may indicate insufficient working capital to support sales growth.
Inventory to Working Capital	= Inventory Working Capital	Indicates the percentage of working capital supporting high percentage indicates operating problems.
Current Assets Turnover	= Sales – Expenses Current Assets	Indicates the number of times current assets must turn over to cover expenditures. Measures control of current assets.
Inventory to Current Liabilities	= Inventory Current Liabilities	Shows the degree to which the company relies on inventory to meet its current obligatations
Profitability Ratios Profitability ratios measure the operating performance of the business relative to sales, assets, and invested capital.
Ratio	Formula	Interpretation
Gross Profit Percentage	= Gross Profit Net Sales	Reflects control over cost of sales and pricing policies. The ratio must be viewed in relation to the client’s past performance and the industry average.
Operating Profit Percentages	= Operating Profit Net Sales	Indicates the company’s ability to control operating expenses. The ratio should be viewed in relation to increased sales and changes in gross profit.
Profit Before Taxes Percentage (PBT)	= PBT Net Sales	Provides a more consistent basis for comparisons. It is also used in the calculation of other ratios.
Net Income After Taxes Percentage (NIAT)	= NIAT Net Sales	Reflects the tax impact on profitability and represents the profit per dollar of sales.
Return on Equity	= NIAT Tangible Net Worth	Measures the return to equity owners and represents their measure of profitability. When compared to the return on assets, this ratio indicates degree of financial leverage.
Return on Assets	= NIAT Total Assets	Reflects the earnings power and effective use of all the resources of the Company.
Leverage Ratios Highly leveraged firms are more vulnerable to business downturns (financial risk) than businesses with less invested capital in the form of debt. Leverage ratios help measure this vulnerabilty.
Ratio	Formula	Interpretation
Net Fixed Assets To Tangible Net Worth	= Net Fixed Assets Tangible Net Worth	Indicates the proportion of net worth that is committed to fixed assets and is not available for operating funds. A low percentage would indicate a favorable liquid position.
Debt to Equity	= Total Debt Tangible Net Worth	Indicates the relation of the owners’ and creditors’ positions. This ratio should be viewed in the light of industry averages.
Current Debt to Equity	= Current Liabilities Tangible Net Worth	Indicates the proportion of debt to total equity that is current in maturity. A high ratio may indicate the need to restructure debt.
Long-Term Debt To Equity	= Long-Term Debt Tangible Net Worth	Measures the relationship of long-term debt to equity.
Coverage Ratios Coverage ratios measure a firm’s ability to service debt.
Ratio	Formula	Interpretation
Time Interest Earned	= PBT + Interest Interest	Shows how well the company is able to cover interest from earnings. Measures the level of earnings decline to meet interest payments.
Operating Fund To Current Portion Of Long-Term Debt	= NIAT + Noncash Expenses Current Portion of LT Debt	Shows the ability of the company to meet its current payments.
Other Ratios There are many ratios that compare certain expenses to sales, and vary depending upon the industry. Each industry also has certain ratios that measure profitability and productivity. Here are some examples.
Ratio	Formula	Interpretation
% Depreciation Amortization to Sales	= Non Cash Expenses Net Sales	Shows the percentage of non-cash expenses. Should be compared to cash outflows for capital expenditures.
% Officers/Owners Salaries To Sales	= Owners’ Compensation Net Sales	Shows the percentage of discretionary salaries paid to owner/managers.
Net Sales per Employee	= Net Sales # of Employees	Shows the general efficiency of the work force generate sales.
Net Sales per Unit Sold	= Net Sales Units Sold	An indication of average sales price, per unit particular to the industry.

by Charles Bosler, CPA, MBA, ABV

No one finds out what it takes to successfully compete in today’s world more thoroughly than the business owner. Public servants do not, as public money will roll in tomorrow to fund their existence regardless of how efficient their decisions are today. Corporate employees do not, as their piece of the big picture is rarely as big as the business owner’s, and only their income is at stake based on their performance, not so much on their reputation and significant amounts of their invested capital.

We all know that we have to compete once reaching the age of reason, but few have to excel in as many areas as the business owner. Areas which must be mastered include sales and marketing, operating at top efficiency, technological advancement as it applies to all aspects of the business, human relations, billing, collections, and other organizational disciplines. The business owner must be especially good in most all of these areas if he expects to grow over the long term. In order to have a chance at financial success, a business must first be headed by one or more persons who are better than average at what they do. After all, how could a business thrive very long amongst competition offering better consumer choices? Anyone succeeding over the long term in the capacity of running their own business has reason to be proud. They did it their way and must have been better than average in the effort. Otherwise, the competition would have edged them out. Indeed, most people are not up for this level of challenge to the extent they will put their financial livelihoods and that of their family’s on the line.

One would think that if he or she nurtured a business for many years and proved its ability to compete in today’s world, they should be able to count on the sale of that business for a good part of their retirement funds. Yet the following statistics taken from the 2001 Business Reference Guide and the International Business Brokers Association imply otherwise.

Number of Privately Owned Businesses with Employees that Sell
	Annual Revenues	# of Employees	Normally Priced	% of All Businesses	# of Businesses	# For Sale	# That Sell
General Business Brokerage	<$750K	<10	<$500K	80%	4,370,000	864,000 1 out of 5	157,000 1 out of 5.5
Larger Businesses	$750K-$2M	10-20	$500K-$3M	9%	590,000	173,000 1 out of 3.5	43,000 1 out of 4
Midsize Company	$2M-$30M	21-200	$3M-$20M	8%	490,000	73,000 1 out of 7	21,000 1 out of 3.5
Larger Businesses	>$30M	>100	>$20M	3%	50,000	8,000 1 out of 6	2,500 1 out of 3

Only one out of three large businesses put on the block during 2001 actually sold. For smaller businesses, the statistics are less favorable. Only 1 out of 5.5, or 18% sold. What about the sole proprietor not having employees and therefore not included in the above table? Their equipment and ongoing customer list is undoubtedly worth something to another competitor. The agreed upon value, however, is most always dependent upon the buyer’s later success in retaining those customers. The reality is, your business might provide you with a decent livlihood for much of your career. But unless your business has the attributes in place which appeal to not just one but many likely buyers, do not bank a comfortable retirement upon the liklihood of selling to just the one, required buyer who fully appreciates your opinion of its fair market value. No buyer will have your specific talents, reputation, and network. Interested prospects will estimate the future cash flow that your business will likely provide them, not you, and the many risks that may result in worse results. If their assessment of the present value of future cash flow is notably below your asking price, most will not even counter with a lower offer.

What exactly is it that business buyers are looking for? This question should be important to business owners long before moving on to other pursuits. If not addressed until late in one’s career, statistics previously shown imply that two-thirds of even the largest privately held businesses put on the block will not receive an acceptable purchase offer in a given year. For businesses having under $750,000 in annual sales, over 80% do not receive an acceptable purchase offer. What additional hoops must the business owner jump through to realize their own opinion of fair market value when it comes time to sell? With sound advice rarely present when such thoughts surface, delay is often the easier emotional choice for many entrepreneurs to make, who identify personally with their company. But with delay, the best opportunities often come and go.

The typical business owner is readily willing to work 50% or more hours per week than the average employee to maintain the company’s profitability and reputation for reliability . Early on, it might have been a lack of working capital that caused the owner to wear many hats. Once doubts about the business being a viable going concern were removed, happiness with the status quo rarely provided continued success. The successful owner had to continue changing because the world continually changed. Long term business owners are not only survivors but usually have the wits to take many along with them. Yet when it has come time to sell, only a small minority of these owners make a convincing case that their business is worth what they think it is. After surviving so many challenges, what is it they fail to do?

Like any successful institution which has survived over generations, top management at least annually should take stock of what they have accomplished, where they are now, where they want to go, and how they plan to get there. The more organized entrepreneurs often do this in the form of written minutes to an annual meeting. Take two businesses that are equal to each other at the moment, with the exception that one is stagnant and the other is moving forward with obvious positive momentum and positive developments in the pipeline. The second business will always be worth significantly more at that point in time, as much of the value of a business comes from extrapolating its future prospects. Making sure that the business has positive momentum and developments unfolding all the time should be thoroughly addressed at least annually. A written action plan for the following year, even if in checklist form, is mandatory if you want others to be able to duplicate your success.

A businessman wanting to someday receive fair market value for his business should answer the following questions at least annually:

Question Number 1. Where are we now?

Maximizing business value begins with identifying the value components and drivers of the business as they exist today. Items enumerated might include superior service, products or processes. They might include a superior marketing plan, and/or key personnel able to accomplish much more than their peers due in part to policies and equipment in place. They might include a position of financial strength and operating efficiencies resulting from past experiences of trial and error. Additional but by no means a complete set of possible attributes as to where you are at now appears in Appendix I . Whatever these value components are, their identification will help your later plan to increase value even more.

Before completing your mostly subjective analysis of where the company is at now, make sure your analysis minimally builds on the following points of interest to prospective buyers someday:

Your company’s history
Your company’s ownership
Your company’s products and services
Your company’s customers
Your company’s facilities
Make up your company’s management
Make up your company’s workforce
Your company’s suppliers
Your company’s competition

On his own behalf, the business owner should also apply himself quantitatively at least annually by monitoring those financial ratios that are most applicable to his business, also measuring financial strength and weaknesses of most interest someday to prospective buyers. Such financial ratios are most often categorized in the following areas:

Liquidity Ratios
Efficiency Ratios
Profitability Ratios
Leverage Ratios
Coverage Ratios
Other Ratios

Appendix II near the end of this article more specifically describes ratios often used by bankers and investment analysts in the above categories. You should annually note how your company has performed in relation to industry averages, which are available at many public libraries. Only after periodic review of the financial ratios most applicable in measuring the financial strength and efficiency of your business, will you more clearly understand what the outsider’s conclusions will be towards the risks, cash flow, and liklihood for internal growth to be expected from your company. Constantly striving towards continued ratio improvements is the same as striving towards a higher valuation for your business someday. If you already know that the financial analysis will be favorable before the prospective buyers do their due diligence, you will find yourself in the driver’s seat when it comes time to sell.

Question Number 2. Where do we want to be?

Most prospective buyers of a business will base their maximum offering price based upon three basic components: current cash flow, current growth prospects, and currently perceived risk factors associated with the business. Accordingly, business owners will be well rewarded later if they regularly identifies the most cost efficient alternatives available to:

increase the Company’s cash flows
increase the Company’s growth rate
decrease in the amount of risks involved in operating the business

With respect to increasing the growth rate, growth alone does not increase the value of a business. Only growth that results in additional cash flow over and above additional working capital required to comfortably accommodate that growth, will result in an increased business valuation. Less disciplined growth pursued for growth’s sake alone often decreases the value of a business. Indeed, low margin growth can and often does result in less cash flows being generated from operations.

If you want your business to be worth more in the future then it is today, you need to widen your focus no farther than towards (a) increasing its cash flows, (b) increasing its growth rate while maintaining or improving margins, and (c ) reducing the many risks associated with your business.

Question Number 3. How do we get there?

By the time you have solidified where you are now and where you want to go, you will have many ideas about the most cost efficient options available to increase your company’s value. Policies put into place should be conducive towards fostering some combination of increasing profitable growth, increasing cash flows and reducing business risks.

Increasing Growth

There are four ways for a business to grow:

More marketing to increase market share
Develop new product lines and services
Buy another business entity or product line
Merge with another business entity.

Which is the cheaper for you to do, make or buy growth? This will essentially be a capital budgeting decision which should be easy to make. Careful analysis will lead you towards the avenue is best for you. From there, you should itemize the steps to likely succeed along the chosen avenue, and put them into effect. If you don’t put the steps into writing, do not expect growth or an increased business valuation to result.

Increasing Cash Flows

Growth is not the only way to increase cash flows. The earlier suggested ratio analysis will help you evaluate how your business stacks up in comparison to competitors. Apparent inefficiencies are an obvious starting place. The world economy is always in a phase of shifting actual production to the most cost efficient suppliers. Have you evaluated all your reasonable options to reduce labor and material costs? Are you turning your receivables over at least as fast as the competition? Is your inventory tightly monitored so as to not to unnecessarily result in waste, theft, or working capital being tied up? Yet inventory availability must still be sufficient to foster growth. Are you purchasing your inventory from the most cost effective source? What about your facilities and equipment? Could it be more efficiently configured ? Is there machinery available that could replace more expensive labor? Has the business sold off its investment in unneeded facilities and equipment, allowing capital to be put to better use?

You run your own business in part because you are more creative and energetic than the next guy. You are costing yourself money if you do not put that creativity to work on your own behalf. You should always have a strategy in place with the ultimate objective of increasing cash flows from existing operations. There are consulting firms who will help you here when you run low on your own ideas.

Reduce the Risks Surrounding Your Business

Businesses which have removed many of the uncertainties about their future cash flows always sell for greater multiples of current cash flows than higher risk operations. General Electric (GE) for instance, has long established itself as being a company which hires only the best employees available. Even then they reward only the top 80% with a graduated level of job security, bonuses, other pay increases, and benefits commensurate with their performance. GE is always introducing new products and/or delving into growing markets currently earning profit margins noticeably better than more mature product lines typically yield. GE abides by a stable debt to equity ratio which has resulted in its Triple A credit rating, a standard which implies treatment of creditors with utmost respect. Basically, investors have come to expect 15% to 20% annual growth in GE’s sales and earnings, and that is most often what they later see. As large as GE is, they still sell at a price earnings ratio most always over 20, a level usually associated with smaller growth companies. One reason is because GE has consistently shown investors in the past that they can count on steadily increased cash flows in the future. It manages and handles everyday obstacles and even the review of growth opportunities in routine manner. Law suits against it are rarely reported in the financial press, as are labor problems, despite their selective hiring policies. By making its future results very predictable, GE’s management has eliminated the perception of their being much risk about its future course and cash flow path. Its management has succeeded in achieving and then maintaining the company in a rather elite class among even the largest of companies. Minimizing business risks in many different areas had to be emphasized by its Board over many years to achieve this recognition. Investors as a result have been paying a premium for its common stock for many years.

While increased value for a business may come more rapidly from profitable growth and by increasing cash flows, generating the same level of cash flows with lower risk also creates value. In assessing vulnerability to risks, not much can be done about the over all economy effecting all businesses. Nor can management readily switch into a new industry by completely changing its customer base in a short period of time. Management, however, can work towards changing the business into a better company. The following areas are often looked at first by outsiders when assessing the level of risk associated with operations:

Access to and the cost of capital
Ownership structure and stock transfer restrictions
Company’s market share and market structure of the industry
Customer concentration
Depth and breadth of management
Distribution capability
Extent of reliance on individuals with key knowledge, skills, or contacts
Workforce competitiveness, employee relations, and reliance
Marketing and advertising capacity/efficiency
Breadth of products and services
Purchasing power and related economies of scale
Customer concentration
Vendor and supplier relations and reliance
Work force competitiveness, employer relations, and reliance
Distribution capability
Depth, accuracy, and timeliness of accounting information and internal control

High rankings in all the above areas equates into low risk operations. See Appendix I for more ideas.

You are undoubtedly able to list significant risk areas surrounding your own business to work on first. What is it most that would make your business vulnerable to uncertainty in a prospective buyer’s eyes? Improve that area and a number of less time consuming or costly areas every year. Smoother operations will result. Your business will be worth more for that reason alone.

Conclusion

As illustrated near the outset, at least two-thirds of all private businesses listed for sale do not receive an acceptable purchase offer in a year’s time. The typical business owner works hard for many years and has probably proven himself financially to be all around superior to peers in capitalizing upon opportunities that surface. When it comes time to move on, is it then time to watch the business wither away, watch past momentus efforts evaporate over a short period while competitor’s take their slice for free? Or can this same competitive businessman turn periodic, slow periods thorughout the year into a time to update his notes on where he is now, where he wants to be, and how he is going to get there. If he does not address these issues well ahead of time, all the more likely he will be cast with the majority.

Up until now, you worked hard to excell amongst your peers. Why stop short when your periodically updated, written notations now mean so much towards how your future years will be lived?

Appendix I

Identifying Valuation Components, Value Drivers and Risk Reducers

Common Value Drivers

Intangibles
Well Defined Mission and Vision Statement Owner’s Particular Product/Services Knowledge Management’s Knowledge, Experience and Depth Motivated and Dependable Work Force Key Employees Bound by Non Compete Agreements Organizational Structure Promotes Efficiency Management Succession Plan in Place Active Outside Board of Directors Long History, Reputation and Name Recognition Management Focus on Growth and Value Creation Industry Regulations Impact Company Profits	Business Plan is Constantly Monitored and Updated Owner’s Personal Relationships with the Customers, etc. Loyal Customers Few Competitors Special Barriers to Competition Strong Supplier Relations Located in a Growing Geographical Market Part of a Growing Industry Reputable Company Advisors Active and Visable in Community and Industry Affairs Economic Conditions Influence Product Demand
Operating
Repeat Customers - Customer List Trained and Knowledgeable Workforce Proprietary Products: Patents, Copyrights Recognizable Trademark or Trade Name Large Market Share (size) Diversified: Products, Customers, Geographic (size Special Franchise Arrangement Exclusive Distributor/Supplier Rights Special Operating Procedures and Trade Secrets Favorable Location to Customers, Suppliers, etc. Market Intelligence Systems in Place	Brand Name Distributor Industry Specialization Special Niche Market Product/Service Differentiation is Well Defined Unique Manufacturing/Production Process Special Services: Delivery, Repair, Warranty Creative Use of Website to Sell Products or Services Strategic Partnering and Alliances Strategic Planning Processes in Place ISO 9000 Registered Vendor EOQ and Other Inventory Control Systems in Place
Investment
Commitment to Human Capital (training, benefits, etc.) State of the Art Technology Equipment Large Inventory Selection (size) On-going Investment in Information Technology	Additional Capacity for Growth (space, manpower, etc.) Well Maintained Capital Equipment Commitment to Research and Development Capital Budgeting Processes in Place
Financial
Key Management Have Incentive Compensation Plans High Margins Due to Efficiencies, etc. Strong Liquidity Position Optimal Financial Leverage Optimal Operating Leverage Favorable Tax Structure Internal Controls are Well Defined Properly Insured Against External Risks	Long-Term Profitable Customer Contracts Purchasing Power (size) Favorable Lease Terms Favorable Debt Financing Terms (size) Financing Plans in Place to Secure Needed Capital Funded Buy-Sell Agreement Budgeting System Controls Costs and Eliminate Waste Budgeting System Controls Costs and Eliminate Waste Systems in Place to Comply with Laws and Regulations

Appendix II

Financial Ratios

Memo: For Industry Averages, refer to Robert Morris' and Associates Annual Financial Statement Studies, or other credible sources maintained by many public libraries.

&

Close

Liquidity Ratios Liquidity is a measure of the quality and adequacy of current assets to meet current obligations as they come due.
Ratio	Formula	Interpretation
Current Ratio	= Total Current Assets Total Current Liabilities	Rough indication of a firm's ability to service its current obligations. Higher ratios show stronger liquidity; composition, however, and quality of current assets is critical.
Quick Ratio	= Cash + Cash Equivalents +Net Receivables Total Current Liabilities	A conservative view of creditors' protection, since and prepaid items may not always be liquid. Generallyratio less than 1:1 implies dependency on inventory and other current assets to liquidate short-term debt.
Working Capital	= Current Assets – Current Liabilities	Working capital is a direct indicator of the company’s ability to grow.
Efficiency Ratios Efficiency ratios measure the ability to manage working capital, fixed capital, and overall return on invested assets.
Ratio	Formula	Interpretation
Accounts Receivable Turnover	= Credit Sales Average Accounts Receivable	Indicates the number of times it takes receivables to turn into cash per year. Attention should be paid to credit terms, billing procedures, trends, and industry average.
Accounts Receivable Collection Period	= 360 or 365 Days Accounts Receivable Turnover	Reflects average length of time from sale to cash collection.
Inventory Turnover	= Cost of Goods Sold Average Inventory	Indicates the number of times the business liquidates its inventory over a period and whether too little or too much inventory is carried.
Inventory – Days In Inventory	= 360 or 365 Days Inventory Turnover	Reflects the number of days it takes to sell the inventory.Used in conjunction with accounts receivable collection period to determine operating cycle.
Operating Cycle	= Accounts Receivable Collection Period + Days in Inventory	Indicates the length of time it takes to convert inventory to cash. If the cycle increases, more working capital is needed.
Accounts Payable Turnover	= (Cost of Goods Sold–Beginning Inventory + Ending Inventory) Average Accounts Payable	Indicates the number of turns per period of time it takes for the company to pay its trade payable. Should be compared to credit terms.
Accounts Payable – Days Outstanding	= 360 or 365 Days Accounts Payable Turnover	Same as for Accounts Payable Turnover (above), but number of days rather than the number of turns.
Assets Turnover	= Net Sales Total Assets	Indicates the turnover rate of total assets to achieve net sales. When viewed historically, the ratio indicates the effectiveness of generating sales from asset expansion.
Net Sales to Working Capital Turnover	= Net Sales Working Capital	An indication of the amount of working capital required to support sales. An increasing ratio may indicate insufficient working capital to support sales growth.
Inventory to Working Capital	= Inventory Working Capital	Indicates the percentage of working capital supporting high percentage indicates operating problems.
Current Assets Turnover	= Sales – Expenses Current Assets	Indicates the number of times current assets must turn over to cover expenditures. Measures control of current assets.
Inventory to Current Liabilities	= Inventory Current Liabilities	Shows the degree to which the company relies on inventory to meet its current obligatations
Profitability Ratios Profitability ratios measure the operating performance of the business relative to sales, assets, and invested capital.
Ratio	Formula	Interpretation
Gross Profit Percentage	= Gross Profit Net Sales	Reflects control over cost of sales and pricing policies. The ratio must be viewed in relation to the client’s past performance and the industry average.
Operating Profit Percentages	= Operating Profit Net Sales	Indicates the company’s ability to control operating expenses. The ratio should be viewed in relation to increased sales and changes in gross profit.
Profit Before Taxes Percentage (PBT)	= PBT Net Sales	Provides a more consistent basis for comparisons. It is also used in the calculation of other ratios.

by Charles Bosler, CPA, MBA, ABV

Number of Privately Owned Businesses with Employees that Sell

Annual Revenues

# of Employees

Normally Priced

% of All Businesses

# of Businesses

# For Sale

# That Sell

General Business Brokerage

<$750K

<10

<$500K

80%

4,370,000

864,000 1 out of 5

157,000 1 out of 5.5

Larger Businesses

$750K-$2M

10-20

$500K-$3M

9%

590,000

173,000 1 out of 3.5

43,000 1 out of 4

Midsize Company

$2M-$30M

21-200

$3M-$20M

8%

490,000

73,000 1 out of 7

21,000 1 out of 3.5

Larger Businesses

>$30M

>100

>$20M

3%

50,000

8,000 1 out of 6

2,500 1 out of 3

Question Number 1. Where are we now?

Question Number 2. Where do we want to be?

Question Number 3. How do we get there?

Appendix I

Identifying Valuation Components, Value Drivers and Risk Reducers

Intangibles

Operating

Investment

Financial

Appendix II

Financial Ratios

Liquidity Ratios

Ratio

Formula

Interpretation

Efficiency Ratios

Ratio

Formula

Interpretation

Profitability Ratios

Ratio

Formula

Interpretation

Leverage Ratios

Ratio

Formula

Interpretation

Coverage Ratios

Ratio

Formula

Interpretation

Other Ratios

Ratio

Formula

Interpretation

by Charles Bosler, CPA, MBA, ABV

Number of Privately Owned Businesses with Employees that Sell

Annual Revenues

# of Employees

864,000
1 out of 5

157,000
1 out of 5.5

173,000
1 out of 3.5

43,000
1 out of 4

73,000
1 out of 7

21,000
1 out of 3.5

8,000
1 out of 6

2,500
1 out of 3

864,000
1 out of 5

157,000
1 out of 5.5

173,000
1 out of 3.5

43,000
1 out of 4

73,000
1 out of 7

21,000
1 out of 3.5

8,000
1 out of 6

2,500
1 out of 3