Last week, I did a post about the five "c's" of credit. The first one was Cash Flow
How do you measure cash flow?
For most small businesses all you have to do is take a look at your net income from your Income Statement and add back depreciation ( it is a non cash expense) and you have a preliminary cash flow figure.
Let's assume you have net income of $25K with $5K in depreciation. That gives you about $30,000 in cash flow. You can use this cash flow to pay on debt, pay out to shareholders, invest in equipment, etc.
Let's now assume you want to purchase a piece of equipment for $60,000. On a 36 month loan @ 8%, your payment will be $1,880/month or $22,560/ year.
Based on your historical cash flow, you have 133% ($30,000/$22,560) coverage. Meaning that your existing cash flow can cover the debt service. If this number is less than 100%, it means that your business does not generate enough cash to cover the payments on the debt.
Most banks want a debt service cushion. Usually they'll want to see a ratio of at least 125%.
This is obviously an over simplification of cash flow. However, it gives you an idea as to how a bank will look at your loan request.
As always, if you would like to have someone review a loan request and give you an idea as to where it stands, email me at gtvcpa@gmail.com
Friday, August 31, 2007
Friday, August 24, 2007
Business Tip Vol. 9 - Obtaining Business Credit
Much has been in the news regarding the current lender problems.
It appears that even commercial banking lenders will soon be having problems of their own soon. One of the reasons both are having problems is that for the past few years they have veered away from prudent lending practices.
As a lender, 11 years ago, me and my bosses continually reviewed the Five "C's" of Credit on each and every deal our bank did. Those "C's are
1) Cash Flow (aka capacity) - Where is the money going to come from to pay off the loan. Usually this is matched with the asset purchased ie If you buy a rental property, the rents will be the cash that pays the loan.
2) Collateral - What I always term the secondary source of repayment. Usually this asset is what secures the loan.
3) Capital (aka net worth) - What other available resources does the borrower have at his disposal to repay the debt. The more liquid the better.
4) Character - The most subjective indicator of repayment. You can usually get some measurement of character by looking at a credit report. Does the borrower pay on time or do you always have to call them for payment?
5) Conditions - What are the general market conditions that could effect your loan? For instance, you would probably rather loan money to technology companies over mortgage companies right now. "Conditions" are generally out of the control of the borrower.
The weaker any one of these "C's" are the stronger the others have to be. For instance, if you have bad collateral, you are going to need to document stronger cash flow and/or capital.
The "C's" are just as important to personal credit as it is to commercial credit.
I can almost guarantee that where a loan goes bad, you will find that one or more of the "C's" was or was becoming a problem before the actual collapse.
In the example of mortgage lenders. Lenders were willing to do 100% financing (collateral) to people who were strapped from day one to make payments (cash flow). When interest rates increased the cash wasn't there to pay the debt and the collateral deteriorated to where foreclosures couldn't pay back the loan.
Beginning next week, I'll illustrate each of these in detail and how you can protect yoruself.
It appears that even commercial banking lenders will soon be having problems of their own soon. One of the reasons both are having problems is that for the past few years they have veered away from prudent lending practices.
As a lender, 11 years ago, me and my bosses continually reviewed the Five "C's" of Credit on each and every deal our bank did. Those "C's are
1) Cash Flow (aka capacity) - Where is the money going to come from to pay off the loan. Usually this is matched with the asset purchased ie If you buy a rental property, the rents will be the cash that pays the loan.
2) Collateral - What I always term the secondary source of repayment. Usually this asset is what secures the loan.
3) Capital (aka net worth) - What other available resources does the borrower have at his disposal to repay the debt. The more liquid the better.
4) Character - The most subjective indicator of repayment. You can usually get some measurement of character by looking at a credit report. Does the borrower pay on time or do you always have to call them for payment?
5) Conditions - What are the general market conditions that could effect your loan? For instance, you would probably rather loan money to technology companies over mortgage companies right now. "Conditions" are generally out of the control of the borrower.
The weaker any one of these "C's" are the stronger the others have to be. For instance, if you have bad collateral, you are going to need to document stronger cash flow and/or capital.
The "C's" are just as important to personal credit as it is to commercial credit.
I can almost guarantee that where a loan goes bad, you will find that one or more of the "C's" was or was becoming a problem before the actual collapse.
In the example of mortgage lenders. Lenders were willing to do 100% financing (collateral) to people who were strapped from day one to make payments (cash flow). When interest rates increased the cash wasn't there to pay the debt and the collateral deteriorated to where foreclosures couldn't pay back the loan.
Beginning next week, I'll illustrate each of these in detail and how you can protect yoruself.
Wednesday, August 22, 2007
Wednesday's tax tip Vol. 19 - Sole Proprietors
I've read numerous articles surrounding increased audits of sole proprietorships.
Because the IRS believes that this is where most of the under reporting of tax exists, they are intensifying their efforts on those businesses. I've read and I know from my own personal experience on audits, the IRS is primarily focusing in on receipts not reported as income.
How do they check this?
In my audit it was as simple as taking all my bank statements and adding up all the deposits. I needed (and fortunately for me, was able) to document any bank deposits that went into my business accounts that were not sales.
So if you transfer lots of funds between accounts or borrow money from lines of credit of over draft protection accounts, you need to be able to reconcile those transfers above and beyond sales receipts.
While on it's face it makes sense for the IRS to hone in on this type of activity, it occurs to me that there is a huge amount of business activity that is never reported on any tax return. I would guess that there are tens of thousands of businesses that never report any income because they work "under the table". No 1099's have been issued and as a result, there is nothing to tip off the IRS as to the reporting of any income.
This is becoming a larger and larger issue with illegal immigrants and citizens avoiding child support or paying any tax all together. But we'll let the IRS deal with those issues.
Because the IRS believes that this is where most of the under reporting of tax exists, they are intensifying their efforts on those businesses. I've read and I know from my own personal experience on audits, the IRS is primarily focusing in on receipts not reported as income.
How do they check this?
In my audit it was as simple as taking all my bank statements and adding up all the deposits. I needed (and fortunately for me, was able) to document any bank deposits that went into my business accounts that were not sales.
So if you transfer lots of funds between accounts or borrow money from lines of credit of over draft protection accounts, you need to be able to reconcile those transfers above and beyond sales receipts.
While on it's face it makes sense for the IRS to hone in on this type of activity, it occurs to me that there is a huge amount of business activity that is never reported on any tax return. I would guess that there are tens of thousands of businesses that never report any income because they work "under the table". No 1099's have been issued and as a result, there is nothing to tip off the IRS as to the reporting of any income.
This is becoming a larger and larger issue with illegal immigrants and citizens avoiding child support or paying any tax all together. But we'll let the IRS deal with those issues.
Wednesday, August 15, 2007
Wednesday's tax tip Vol. 18 - Exemptions for the Divorced
If you are or anticipate being divorce in the near future, who claims the dependents on their respective tax returns?
The IRS specifically permits the custodial parent to claim any dependents for their returns regardless of child support or other agreements between the parties.
The only way the IRS permits any noncustodial parent from claiming the dependent(s) is through use of the form 8332 to be completed by the custodial parent. This form essentially grants the non custodial parent to claim an exemption.
Please keep in mind that this form is to be completed regardless of any agreement in a divorce decree. The IRS would tell you they are not in the business of reviewing and determining dependent exemptions for hundred of thousands of decree agreements, some of which can be very detailed.
When and if you are in a position to negotiate the claiming of dependents on your returns, make sure your attorney includes this form as part of your decree documents.
The IRS specifically permits the custodial parent to claim any dependents for their returns regardless of child support or other agreements between the parties.
The only way the IRS permits any noncustodial parent from claiming the dependent(s) is through use of the form 8332 to be completed by the custodial parent. This form essentially grants the non custodial parent to claim an exemption.
Please keep in mind that this form is to be completed regardless of any agreement in a divorce decree. The IRS would tell you they are not in the business of reviewing and determining dependent exemptions for hundred of thousands of decree agreements, some of which can be very detailed.
When and if you are in a position to negotiate the claiming of dependents on your returns, make sure your attorney includes this form as part of your decree documents.
Wednesday, August 8, 2007
Wednesday's tax tip Vol. 17 - Sales Tax
Business owner's ask me often about sales tax. When they should charge or not charge it.
In general, Ohio sales tax is charged on any product not for resale. For instance, if you sell soda to a business who provides it for their employees, you must charge sales tax. If you sell it to a merchant who intends to resale it, you do not charge the sales tax.
If you think of it this way, only one business charges sales tax. The only business that charges sales tax is the business that sells the product to the end user.
To muddy the waters a little more, some services are subject to sales tax. Manicure services, lawn services, massages, etc. are subject to sales tax. Legal and medical services are not subject to sales tax.
In addition, sales tax is not charged to any tax exempt, non profit business.
If a business, communicates that they are not subject to sales tax, you must obtain a copy of their vendor's license for your records. Otherwise, you could be legally liable for the tax due.
If you have a question regarding the sales tax, please email me at gtvcpa@yahoo.com
In general, Ohio sales tax is charged on any product not for resale. For instance, if you sell soda to a business who provides it for their employees, you must charge sales tax. If you sell it to a merchant who intends to resale it, you do not charge the sales tax.
If you think of it this way, only one business charges sales tax. The only business that charges sales tax is the business that sells the product to the end user.
To muddy the waters a little more, some services are subject to sales tax. Manicure services, lawn services, massages, etc. are subject to sales tax. Legal and medical services are not subject to sales tax.
In addition, sales tax is not charged to any tax exempt, non profit business.
If a business, communicates that they are not subject to sales tax, you must obtain a copy of their vendor's license for your records. Otherwise, you could be legally liable for the tax due.
If you have a question regarding the sales tax, please email me at gtvcpa@yahoo.com
Monday, August 6, 2007
Personal Financial Tip Vol. 12 - Credit Cards
I'm often asked about the pro's and con's of refinancing credit card debt via a home refinancing and/or a home equity loan.
In general, here's my answer.
Don't do it.
First, keep in mind that credit card purchases are generally for short lived purchases. To refinance is essentially financing a trip to the Olive Garden for 15 years.
Second, inevitably you'll find that as soon as you pay off those cards, you'll have those very cards racked up in debt again.
Third, going through the process of aggressively paying off cards will develop your budgeting skills to pay off short lived purchases.
Fourth, credit card debt is unsecured, by placing on debt against you're home you'll be making your home subject to creditors and possible foreclosure.
What I recommend is a predetermined budget of your debt as well as all your monthly bills.
Let's say It looks like this
Mortgage $1,000/month (80,000 total)
Car $385/month (15,000)
VISA $154/month (8,750)
Mastercard 137 month (5,750)
Macy's Card 20/month (1750)
Gas card $20 (580)
Start by budgeting for how much you can pay on your debt every month. In this case, let's assume you have 2,100/month for debt payment.
Begin by paying the minimum for everything but the smallest balance. When those are paid place the remaining (in this case $384) on thesmallest balance. Don't worry about the interest rates.
You'll find that as soon as you have that gas card paid off, you'll be building momentum against the remaining debt.
If you don't believe it can be done... believe me it can. I did it and my situation looked worse than this one.
In general, here's my answer.
Don't do it.
First, keep in mind that credit card purchases are generally for short lived purchases. To refinance is essentially financing a trip to the Olive Garden for 15 years.
Second, inevitably you'll find that as soon as you pay off those cards, you'll have those very cards racked up in debt again.
Third, going through the process of aggressively paying off cards will develop your budgeting skills to pay off short lived purchases.
Fourth, credit card debt is unsecured, by placing on debt against you're home you'll be making your home subject to creditors and possible foreclosure.
What I recommend is a predetermined budget of your debt as well as all your monthly bills.
Let's say It looks like this
Mortgage $1,000/month (80,000 total)
Car $385/month (15,000)
VISA $154/month (8,750)
Mastercard 137 month (5,750)
Macy's Card 20/month (1750)
Gas card $20 (580)
Start by budgeting for how much you can pay on your debt every month. In this case, let's assume you have 2,100/month for debt payment.
Begin by paying the minimum for everything but the smallest balance. When those are paid place the remaining (in this case $384) on thesmallest balance. Don't worry about the interest rates.
You'll find that as soon as you have that gas card paid off, you'll be building momentum against the remaining debt.
If you don't believe it can be done... believe me it can. I did it and my situation looked worse than this one.
Wednesday, August 1, 2007
Wednesday's tax tip Vol. 16 - Gift Tax
Maybe one of the most misunderstood tax laws is the gift tax. Here is a FAQ on the IRS site about gift taxes.
In general, the giver of the gift must pay gift tax if the amount of the gift exceeds $12,000 per person, per year (2006 & 2007). The receiver of the gift does not claim the gift as income or need to pay gift tax from receipt of the gift.
For example, let's assume you decide to give your child $20,000. That gift would be subject to gift tax. However, a married couple can each give the $12,000 to that child meaning that no gift tax is now due.
In addition, you could give a family of four up to $48,000 and, if married, up to $96,000 to that family each year.
Another myth buster.... Gifts to individuals are not deductible (for federal income tax purposes) for the giver, regardless of the circumstances. The only deductible gifts are to qualified 501(c)3 charities.
Like most tax advise, this is a simple rule of thumb, if you want an answer to your particular situation, talk to your adviser or email me at gtvcpa@yahoo.com.
In general, the giver of the gift must pay gift tax if the amount of the gift exceeds $12,000 per person, per year (2006 & 2007). The receiver of the gift does not claim the gift as income or need to pay gift tax from receipt of the gift.
For example, let's assume you decide to give your child $20,000. That gift would be subject to gift tax. However, a married couple can each give the $12,000 to that child meaning that no gift tax is now due.
In addition, you could give a family of four up to $48,000 and, if married, up to $96,000 to that family each year.
Another myth buster.... Gifts to individuals are not deductible (for federal income tax purposes) for the giver, regardless of the circumstances. The only deductible gifts are to qualified 501(c)3 charities.
Like most tax advise, this is a simple rule of thumb, if you want an answer to your particular situation, talk to your adviser or email me at gtvcpa@yahoo.com.
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