Let’s begin at the beginning. An asset is something of value that we own or control such as equipment. The value of equipment decreases with usage and age. When we buy it, we record its value on our Balance Sheet at the purchase price of $100,000. Now wait five years, run off a few million impressions and sell it. We won’t get $100,000 for it. Of course not.

What we will get varies but let us say we get $10,000 after five years. So, what did the equipment cost? It cost $90,000 ($100,000 – $10,000). Now, WHEN was the $90,000 “used up?” In year five when we sold it? No, obviously, it was over the five year period or $18,000 a year on average.

Now, as a business owner, do we want to wait until year five to recognize the $90,000 cost of the equipment or would we prefer to “estimate” the loss in value each year and thus reduce our income taxes in these in between years? Duh.

And this is where the whole argument of an “estimate” and the fact that it’s not “real money” comes into play. Well, it is real money. Just follow the cash trail. We pay $100,000 from our checkbook on day one to get the equipment (borrowing to pay for the equipment is a more complex explanation but essentially is similar to this example).

Now in year one (disregarding any Section 179 or bonus depreciation) we charge $18,000 against our earnings as depreciation. That’s the same depreciation that my friend argues isn’t real money. Well, what happens to the $18,000? It goes back into our checking account to replenish the $100,000 we withdrew to buy the equipment. So, in year one, we withdrew $100,000 and put $18,000 back in leaving us down $82,000 on the transaction.

In year two, we charge another $18,000 estimate in the form of depreciation so we deduct that from the $82,000 negative balance and we have a negative $64,000 at the end of year two. At the end of year three our balance is $46,000; year four at $28,000; and year five at $10,000. Again, at the end of year five we sold the equipment for $10,000, so when we put that money in the bank, our balance on this transaction is now $0. We took out $100,000 from our checkbook and we put back in $100,000 through depreciation and the final sale on the equipment.

So, does depreciation represent real cash? Yes.

The example is essentially the same when we borrow money to buy the equipment although it’s a little harder to see. The cash on day one doesn’t come out of our checkbook; rather the bank puts $100,000 into our checkbook in exchange for a note (loan). We then pay it out to the equipment vendor.

Our depreciation calculation is the same so we’re estimating a cost of $18,000 each year to go back into our checkbook. Difference here is that it doesn’t stay there. No, we then make a “hidden” payment to the bank on the note. That payment is made up of two components: principal and interest. Interest is the cost to us for borrowing the money and shows up on our income statement. But the principal is the amount we reduce the loan we owe so it’s not an “expense.” Rather, it’s like a distribution, dividend or withdrawal. We take cash out of our checkbook and pay down our debt. No expense is involved. And this is why it is a “hidden” transaction for it doesn’t show on the income statement.

So, in this case as well, depreciation represents a real cost to the business. Depreciation allows $18,000 to be charged against income and increases our checking account the same as in our first example. The difference is that we then pay interest and principal on the loan which decreases our cash. But the principle is the same. Depreciation represents real cash.

Yeah, butta what happens if we lease the equipment?

You certainly are full of questions today, aren’t you? When we lease equipment, we are in fact renting the equipment long term. That means the equipment does NOT go onto our balance sheet as an asset and we do NOT recognize depreciation on it. Rather, we pay the leasing company a rental fee each month which is deducted straight up from our income as equipment rental and depreciation just like rent.

Anyway, I trust that this explanation clears it up for everyone. Well, at least maybe it helped a little.

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According to the 2012 deduction limit is $139,000. This is the amount of new or used equipment (or software) you may purchase, put into service and write off as a direct deduction to your income this year. What’s bad about that? Nothing is bad, specifically. What’s bad is the way you PAY for the equipment. IF you purchase equipment and PAY CASH for it in 2012, then, by all means take the deduction. But if you borrow money to buy the equipment you need to realize that Section 179 saves you no money in the long-run.

Huh? In simple terms, when you buy equipment you may depreciate (recapture your investment) according to the Internal Revenue Service’s Modified Accelerated Tax Recovery System (MACRS) which means you offset income OVER TIME. In real simple terms, should you purchase $100,000 in equipment and write it off over five years (it’s more complicated than this), then you would depreciate about $20,000 per year (more in early years and less in later years). So, if you pay cash, you are out $100,000 in year one and write off only $20,000 in year one. Then your year two through five depreciation deductions eventually catch up and you have deducted $100,000 over a five year period.

But if you borrow the money in year one ($100,000) and deduct the entire $100,000 in year one while only paying out $20,000 in cash, then your year two through five payments of $20,000 have no offsetting expense deductions leading one to exclaim, “If I’m making all this money, how come I have no cash?”

So, if you pay cash, then deduct it this year using Section 179. If you borrow money for the equipment, then you are better off matching your depreciation deduction more closely with when the cash goes out.

Further problem

The panic to buy equipment at the end of the year often results in us buying equipment we don’t need or which hasn’t been proven.

Here’s a further explanation from my 2011 alert

Section 179 Accelerated Depreciation in the U.S. does just that. It does allow you to accelerate or move your depreciation deductions you would take during out years to this year, but it provides NO additional deduction. Over time, you have exactly the same tax effect.

Okay, you might be thinking, “What is wrong with taking the depreciation this year instead of waiting?” Follow the cash to find out.

If you pay little or no money down to purchase $50k of equipment this year, you probably can deduct the amount as an expense and reduce the amount of income tax paid this year. “Well, isn’t that saving money? No, because there’s always next year.

Next year you still have to repay the loan (cash out) but you have NO offsetting expense deduction (depreciation). So, we get upside down in our car payment, so to speak. We pay out $12,500 of cash to repay the loan in out years and have $0 of expense deductions, which means we are paying MORE taxes in out years, precisely when we have less cash because of the payments. Had we delayed the deduction, our depreciation expense deduction would roughly offset the cash out.

What should we do? Again, follow the money. If you pay cash for equipment, then take the Section 179 deduction. If you finance, however, you are usually better off deducting depreciation normally.

That way you will have less of those confusing moments when the accountant says you made a lot of money, yet you are wondering where in the world is the cash.

A synopsis of Section 179 from Section179.org may be found at

The above is an overall, “simplified” view of the Section 179 Deduction for 2012. For more details on limits and qualifying equipment, as well as Section 179 Qualified Financing, please read this entire website carefully ->

Tom Crouser

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Click Here to View Prospering Webinar

What’s Prospering about? It’s about our kinds of businesses … where we raised our equity from our family rather than the stock market. We review the five steps needed in our kinds of businesses as well as why the steps are important along with details in each step. It’s an overview that will be useful to you … especially if you work with a family member in your business.

Some highlights:

Who we really are and how we are different than big businesses. What our families deserve and what the business deserves. Learn two very essential financial ratios. Learn how to read the income statement quickly. Organize around functions, not people. Understand our Battleground and how the Laws of Supply and Demand relate to our business. Learn the two most common challenges we will face even if we do everything else right.

To view, click here and start the program. It’s that simple and it’s 40 minutes. If you have questions, please feel free to message me at tom@crouser.com or give me a call on my cell (304) 541-3714. There’s no cost or obligation.

Click Here to read an article on Prospering.

Want a copy of the book? To read more about the book, Prospering, or order, Click Here. It’s $19.95 which includes shipping in the US.

Prospering’s essence means we have taken care of the simple problems and are prepared to take care of the complex problems as best we can. A successful company is one that can withstand adversity. We are strong, not weak. It doesn’t mean we won’t face adversity, only that we are better prepared to do so. And we are in charge of our own preparedness.

These 5 Steps to Prospering attack our simple and avoidable problems. Simple problems are the lack of cash, the lack of organization, the lack of people stepping up to the responsibilities of their function, and the lack of demand for the organization’s capacity, as well as the predictable prospering issues of raising rich kids and transitioning the business. Complex problems are far more serious and deal with human as well as business adversity. We must prepare our businesses to withstand adversity.

Again, to see the free video, please click here.

Tom Crouser

The post Prospering Video Available to All appeared first on Crouser & Associates, Inc..

These 5 Steps to Prospering attack our simple and avoidable problems. Simple problems are the lack of cash, the lack of organization, the lack of people stepping up to the responsibilities of their function, and the lack of demand for the organization’s capacity, as well as the predictable prospering issues of raising rich kids and transitioning the business.

Complex problems are far more serious and deal with human as well as business adversity. We prepare our businesses to withstand adversity.

Five Steps to Prosperity

Through the last twenty-five years of work with family-based businesses and the previous twenty years spent in my own family-based business, I found five common challenges that must be faced in order for family-based businesses to prosper. Regardless of the specific business, these challenges remain the same and require us to take action. So they form our five steps to prosperity.

These five steps build on each other and are in order for a reason. They start with the most basic and move upward. We must attend to step one first and then move on to step two. However, the activities of a previous step must continue until all steps are being done at the same time.

The five steps are unified. They go together. Failure in an early step can never be overcome by a greater activity in a later step. We work with businesses over a period of time rather than with single assignments, and I see companies return to significant problems when they stopped completing earlier tasks in favor of later ones. They all must be done all the time.

These steps, however, rest on some basic understandings.

Understand that the information within these steps isn’t all-inclusive. Try as I might, I have not been able to include every activity or explanation suggested by the step or answer every possible question. Luckily we live in an age where we may continue to have a dialogue on this subject.

And understand that I do not hold myself out as the “perfect person” or the “perfect business family,” or as role models of any sort. These principles have taken me a lifetime to uncover and, along the way, I violated most of them at one fork in the road or other. So I, especially, am no role model.

Like others having learned of these principles, I try to live them every day as best as I can. But principles are tough. We don’t always do what we should do every time. But that is a human defect and a reflection on me and not the principles.

From this search the development of these five steps evolved.

The five steps are:
1. Awaken
2. Get Financials
3. Get Organized
4. Understand the Battleground
5. Prosper, but Understand the Rules

Step One: Awaken

The awakening begins with accepting the challenge of Prosperity’s Litmus Test.

We must provide to our families more time and more money, not less, because we are in these businesses. It is not for the family to persist in sacrificing for the business. The business is but a means to our family’s prosperity and is not the end itself.

If our business is not allowing the family to prosper, then we must fix it, or close it up and find a real job where we can provide more for our stakeholders.

Philip C. McGraw, in his book Life Strategies, describes his Life Law #1, “You either get it or you don’t.” Unfortunately too many otherwise sane business owners just don’t get it.

We’ve seen whole families sacrificed to some artificial principle—sales growth for growth’s sake or having the biggest piece of equipment or the snazziest office—only to be foiled in the end by their own misunderstandings.

We’ve also seen many people use the business as an excuse to avoid the family. “If I went home, then what would I do?” “I have to come to the business when no one is here. That’s when I get my work done.”

Some family-based businesses I see truly are prospering. They provide more time and money, and the business has enough working capital (current assets minus current liabilities, as explained in the financial chapters) to adequately protect itself from adversity.

But this isn’t most businesses.

Most businesses do not have the working capital needed to foster prosperity or, specifically, they do not know how to get it and keep it. This failure separates truly prospering businesses from those faking it.

Working capital is the Holy Grail of business. Without it, businesses die. With enough, the business is protected and the family may prosper. However, worse than dying is having enough to survive but not enough to succeed.

That’s the highway of purgatory. That’s the living hell: working long hours, earning little money, and having no money so every day and every deal has to go just right in order to exist. But just think, you’re in business for yourself! Still, I respect people in purgatory.

There’s another class of owners who are just faking it. Those people just take more time and more money from the business, whether earned or not. Owners who are truly prospering can take the excess without ever doing damage to the business or the family, but those faking it can’t.

Owners who are faking it end up with hapless stress—living beyond the business’s means. It’s compounded when children are bought off rather than raised, intensifying the problem. The lack of working capital is not only the death of most of these businesses, but also the death of many of these business owners who fall to stress-induced heart attacks and strokes.

Men and women who accept the challenge and find themselves falling short have felt something missing for some time. They just haven’t been able to identify what was wrong. That “something” has to do with cash (specifically working capital), time, or a combination of the two.

Owners who are in denial deny the need for what these principles have to offer. They deny the existence of concerns among their family members or workers in the business. They focus everyone’s attention, energy, and time on the business itself, as if serving the business is a higher calling than serving the family. It is not.
The awakening includes other truths as well, such as awakening to the fact of who we really are and where we came from, which dispels the entrepreneurial myth. We must awaken to the fact that our prejudices affect what we do, how we do it, and how we judge those who work for us. And we must awaken to the different ways we can combine our family and business life and how it affects each of our roles.

Denial of the awakening—usually on the part of the male—can keep the enlightenment from ever occurring. The family can then spend the best twenty and thirty and forty years of their lives chasing a false god. People who are awakened to the reality but choose not to do anything about it lack courage.

“Intentions – Actions = Squat” (Blanchard and Johnson, One-Minute Manager).

Companies whose owners have not yet awakened are in a state of denial. Companies whose owners have awakened but not acted are in a stage of awareness. Failure in this step is caused by denial, lack of training, lack of desire, or lack of action.

Step Two: Get Real Financials

Like it or not, prospering is measured through real financial statements with timely and accurate information that are understandable to all.

Until the business has a real set of financials and until principal stakeholders can read and interpret them, prospering cannot occur because no map exists to show where we have been (financial statements) or where we are going (budget).

Even the way the business game’s score is kept is unknown to most. The balance sheet, not the income statement, is the scoreboard. Reading and interpreting the financial statement is the single most un-mastered skill among business owners and leads to starvation due to lack of working capital.

This is not to say that any stakeholder should spend their time as accountants at the expense of being the leader of the business. That approach wastes valuable resources.

The stakeholders, however, must know the basic language of finance and be able to read and interpret a financial statement. Fail to have this knowledge and you are lost at sea. Rowing, no matter how hard, will not rescue you from the failure to go in the right direction.

As a corollary, even those who do not know where they are going are sometimes right. These few successes give rise to much conventional wisdom that is seized upon by the untrained owner. Little if anything is ever heard from the owners who did not succeed since they carried their lessons to the grave.

Real financials and the ability to read and interpret them, however, do not make a business prosper. People doing the business of the business make the business prosper. Fail to recognize this and the business owner will succeed at being accurate, but never at being prosperous.

When stakeholders fail to know how to read and interpret financial statements, then they cannot deal with facts. If they are not dealing with facts, then they are dealing with feelings.

There is an endless battle among business families based on feelings. One feels more, faster, better, snappier, cooler, bigger, and brighter. When explored, these feelings are often found to be rooted in expanding prestige for the individual, not wealth for the family.

Another fears change. They feel uncertain and seek steadiness and risk aversion, avoiding debt and craving cash on hand. Sometimes this method has been rooted in the reality of dealing with the consequences of those who feel that more and faster is the way, yet sometimes this is an abnormal urge.

There is another way. Facts help families deal with reality without resorting to feelings, hunches, intuition, conventional wisdom, and gambling.

And some founders, when confronted with financial facts, choose to scorn, belittle, disregard, or ceaselessly debate these facts. They choose to ignore; therefore, their failure is based upon ignorance.

You may eliminate many of the stresses in a business family by educating stakeholders on financial facts and measurements, thus allowing the family to focus more on facts and less on feelings. This approach, by itself, reduces the stress of most business families.

Failure in this step can result from faulty information and/or the lack of courage to take appropriate actions once the truth is known. Failure can also occur in this stage by those who become paralyzed by analysis or by those who refuse to perform their leadership responsibilities of dealing with people. People who understand the facts but choose to ignore them act out of ignorance and disdain for the family.

Step Three: Get Organized

We must organize around functions, not people. Then the organization must be led by the leader for the benefit of the family as well as the customers of the business.

Al Ries, in his book Focus, says that the purpose of a business is to “find and keep customers.” I agree but I would add one point. The purpose of our business is to find and keep customers to benefit the stakeholders as well as the customers.

To do this we must organize. In our business world we are the victims of no organizational structure and of organizing around people, not functions.

We don’t need to manage while we walk around. We do too much of that now. We need to be intimately involved in the business of our business and need to be providing leadership to those working with us. We don’t need more communication. We need more skills in hearing what others say.

We don’t need less structure; we need a structure. We need functions reporting to other functions with real people stepping up to the responsibilities of the functions and being held accountable for performance, whether they are related to us or not. And we must begin by separating the function of owning from doing. One may own a car, but a leader still has to step up to the responsibility of driving.

A business is not an investment. It is a requirement of risk and activity on the part of the owner in return for reward. In most investments, one can only lose the investment itself. In a business, one can lose the investment as well as the house, the car, and the family’s future.

Goals, or where we are headed in the first place, are a fundamental part of the organizational step as well as an activity of the group. Surely we are greatly influenced by the leader, but the leader has no right to drive us off a cliff or into dangerous territory.

Once leadership and goals are established and a person actively performs the necessary tasks of driving the business, then others may be recruited to assist. Some of these assistants may be family members, but they don’t have to be.

Stakeholders—our family—are to be guaranteed only that they will receive more time and more money than if the person driving was doing anything else. No one stakeholder has a right to a job because of birth.

The person stepping up to the responsibility of running the business must have all of the business functions covered—operations, sales, and finance (or steering, acceleration, and braking). We must understand what each function does and how to use each function, and we must have qualified people to assist in each area—qualified, even if they are related.

Then we must understand how to delegate, not abdicate (Gerber, E-Myth Revisited), the operation of functions and, most importantly, how to hold others as well as ourselves accountable for results.

The leader’s failure to accept the responsibilities of command can cause failure in this step, as can the leader’s lack of training, skill, or courage. Or a failure can result from a lack of vision.

Lack of performance on the part of a subordinate can cause a failure. But a failure of a subordinate to perform is the failure of the leader because the leader maintains the organizational discipline.

Step Four: Understand the Battleground

Most business owners misunderstand the laws of supply and demand. They think there is a direct correlation between price and sales. There is not. That’s because they don’t understand the battleground of monopolistic competition or the rules of competition under the condition.

Further, many suggest the theoretical approach that businesses perform their marketing first. Some analysts say that we should find a need and then fill it. That’s not the way I see our world.

I find that we are already providing goods or services to an existing set of customers. And that, by itself, places blinders on us. We don’t have working capital. We aren’t getting good margins. And we are fearful of doing anything—like raising prices—with our existing set of customers because we have no options but to serve these low-margin customers with high-cost goods and services. Poor us. Since we live on the edge of failure, changes in the relationship with our customers cannot be chanced.

We do not understand the battleground.

We sit and suffer. We do not take the steps necessary to exit the condition. We do not sell anything to anyone. More formally, we do not create demand for our existing capacity. We also don’t understand what our battleground looks like, nor do we have pricing backbone.

Therefore we either assume we have no choice but to remain poor or we often choose the wrong solution option.

We frequently focus on sales growth as the ultimate answer. After all, it worked for us before. In so doing, we sometimes accept marginal business, or we discount. Or we expand what we sell to the same customers.

With an understanding of the battleground, we learn to create demand for our existing capacity and think inside our box, resulting in more cash with less work.

When management creates demand for current offerings and uses wisely the cash generated, working capital increases. As working capital increases, time and options for the leader increases.

Working capital equates with time since cash allows management more time before it must act. While that may sound curious, relate it to a person’s job. Compare if we were fired today and had nothing in the bank versus being fired but had twelve months’ worth of cash. With cash or working capital, we have more options before we have to do something. The same is true with a business. Cash is time.

Cash also means options. Without cash, we have to deal with the customers we deal with, because we can’t afford to attract better customers—and that’s because we have no cash. We’re circling the drain.

With cash, however, we can afford the luxury of having time to locate better customers. To infuse cash into our businesses, we must create more demand for our existing capacity.

Don’t add marginal business (discount) or broaden your product line (expanding capacity) as a solution at this point. Both use cash before they create cash. Instead, improve your working capital first by creating demand for your existing capacity. In short, go sell something to someone.

Once working capital is improved, then you can do your marketing. Determine what customers need (not want) and create an operating system to fulfill the need. Given enough working capital to allow underperformance while research (time and effort) is being conducted, this approach can be financially successful. But the time and effort can only come if the company has working capital (cash) in the first place. And our businesses don’t; at least, the vast majority don’t.

Within the “understand the battleground” step is also the issue contained within selling, specifically the price at which we sell our products and services. Many owners misunderstand economics and apply the wrong rules, ending up with low prices and high costs.

Others have no pricing backbone because they can’t afford to have pricing backbone, and they don’t know how to develop it. Others have no understanding of negotiation.

Marketing is not the answer for the cash-starved struggling business. Selling existing capacity is. Marketing is a prospering issue.

Business owners who misunderstand economics, have no pricing backbone or negotiation skills, or who do not apply the principles of each will remain nonprosperous forever.

Failure in this step is a result of the leader’s lack of courage to sell or their lack of understanding the basic concepts of the battleground, including the role of price or negotiation.

Step Five: Prosper, but Understand the Rules

A prospering company has owners who understand the purpose of the game. A prospering company has a good financial base and good financial information, is organized around functions not people, is aggressively involved in acquiring and keeping customers on the real battleground of monopolistic competition, and focuses on the sale of existing capacity.

They are additionally looking over the horizon, not for a savior strategy to rescue them from death, but for new thinking and new opportunities through marketing. These activities then create an environment in which the family and business can both prosper for the benefit of the customer as well as the family.

But having a well-financed, well-led, and organized selling machine that is actively acquiring and keeping customers doesn’t mean the family or the business will be able to avoid challenges. Prospering is not without problems or challenges, but it does present different problems and challenges.

Regardless of how good things are today, they will turn bad. No matter how bad things are today, a brighter day will come. That is the sine wave in nature. So, as with military strategy, we must not deal with the intent of the enemy, we must prepare for the enemy’s capabilities.

We don’t even have to have a recession for things to go bad since we live in the micro, not the macro. The macro is the overall economy. We don’t live on Wall Street (the macro); we live on Main Street (the micro). Even in the best of times, the biggest employer in town can be bought up and moved, providing a recession for us regardless of how the rest of the economy is doing.

So the foremost challenge of the prospering stage is to make sure our businesses can withstand adversity by protecting our working capital. After all, enough working capital is the core definition of prospering in the first place.

Families and businesses face two other highly predictable challenges while prospering.

Raising Rich Kids

Dr. Léon Danco (Inside the Family Business) said the most predictable crisis in any business is when we send the kids off to college, because we don’t prepare financially. We assume we will pay for education as it occurs—out of the business.

Then, while the business is being strapped for educational funds and our working capital is low, another crisis hits, such as the biggest employer in town being moved. Or the resignation of a key employee. Or the challenge of having to retool. Or a hot retail trend that falters, leaving us with unsellable inventory.

People like us, who usually come from modest backgrounds, want more for our children than we have. Couple that with our focus on the business, and it is not uncommon for us to buy our children off by exchanging time with them for gifts borne of guilt.

One result of this tradeoff is that instead of our children learning our values, they learn to obtain things without working. The result usually is rich kids—living with a rapidly increasing social and economic status—who rarely appreciate the family farm or the farmers.

This dynamic creates unusual situations like buying two non-working and college-attending sons Mercedes-Benz sports cars while the business has little working capital. Or like paying a high-school-educated son $150,000 a year for working in the business and the son telling us that he doesn’t see how either he or his wife would be able to get by on any less.

Danco adds to our understanding by stating grown children of prosperous parents do not necessarily adopt the values of the parents, although the parents assume they will.

Stanley and Danko (The Millionaire Next Door) carried out specific research on the topic and commonly found adult children with trusts as being underaccumulators of wealth, often making ends meet only through continual gifts of the parents.

I have seen many instances of underperforming businesses whose owners have trusts or anticipated inheritances and who seemingly play business in order to have something to do until they inherit. I’ve rarely found their businesses to be prosperous, probably because they don’t have to be.

In many instances, prosperous parents in their latter stages of life are resented by their children for spending money on themselves. The children—left untrained—often think the parents’ money is the children’s, and they see the parents as wasting it.

On the flip side, I have seen children that were trained who have not only successfully taken over the business of the parents, but also who have bettered the business.

One son in Tennessee has a lot of money in the bank and is on his way to retiring at forty-five instead of sixty-five as his father did. Another child in Pennsylvania turned a very good business into a $60 million-plus national sales organization—a great business. The difference was the parents learned or happened to apply some of the basic family-business principles that encouraged growth, responsibility, and a logical transition.
Transitioning the Business

Hopefully, someday we founders realize we are mortal and face the reality of planning to transition the business. Sometimes the realization comes early and sometimes it comes far too late. Sometimes we just die at our desk and let others worry about such things. Either way, transitioning is the second most predictable crisis faced by the business.

Whether this transition is in the form of the business being operated by the succeeding generation—or the business being sold and assets left to the next generation—matters little. Transition still will occur, planned or unplanned.

Little did we realize when we birthed them, but a successful transition began with raising our rich children. Their attitudes, opinions, and lifestyles all at once matter when we think transition. These things never mattered before, but that was when the next generation didn’t matter. We were working hard to provide all of us a successful life. They were just growing up. Unfortunately, many were just being bought off. Raise them with a profound understanding of exactly who they really are and what their role is on the “family farm,” and they will be better prepared to be worthy successors.

Nevertheless, they and the way they were raised matter now. And what’s worse, their life’s partners matter. And we deal with it for better or worse—usually worse but occasionally better. When the latter happens, the result is a beautiful spectacle, generations standing on the shoulders of previous generations (Danco).

Core to the problems of transition is the concept most parents possess that fairness means equal. It doesn’t. Only the equality of opportunity is fair.

Danco says we must select, train, and install a successor in our lifetime. I second that statement.

Failure during transition usually involves a lack of planning, the lack of educating children to the realities of family-based business, or a lack of courage among the parents to choose.

Our Real Objective: Strength, not Weakness

There are simple problems and complex problems. Simple problems are fixable and straightforward. Complex problems are not.

Prospering’s essence means the family and the family’s business have taken care of the simple problems and are prepared to take care of the complex problems as best they can.

A successful company is one that can withstand adversity. We are strong, not weak. It doesn’t mean we won’t face adversity, only that we are better prepared to do so. And we are in charge of our own preparedness.

Our 5 Steps to Prospering attack simple problems. Simple problems are the lack of cash, the lack of organization, the lack of people stepping up to the responsibilities of their function, and the lack of demand for the organization’s capacity, as well as the predictable prospering issues of raising rich kids and transitioning the business.

Complex problems are far more serious and deal with human as well as business adversity. We prepare our businesses to withstand adversity.

After all, our families deserve a better living because we have these businesses, not a worse one. Our families deserve more time together because we have these businesses, not less time. Our families deserve and expect us to protect our businesses as the source of our family’s income, not destroy them through our action or inaction. Therefore, we accept the challenge of Prosperity’s Litmus Test.
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We will provide to our families more time and more money, not less, because we are in these businesses. It is not for our family to persist in sacrificing for the business. The business is but a means to our family’s prosperity and is not the end itself.

If our business is not allowing the family to prosper, then we will fix it. We will fix it or we will close it and find a real job where we can provide more for our stakeholders.
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Family-based, lifestyle businesses must take five steps in order to prosper. They are the Awakening, the Financial Step, the Organizational Step, Understanding the Battleground, and the step of Prospering.

Tom Crouser

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+ Question: What have you found to be the most common cause/source of decreased cash available for profitable companies? What do you recommend be done to minimize this?

Tom: For profitable companies, the most common issue is that an increase in sales requires cash to be used for an increase in receivables and/or inventory. You don’t necessarily want to minimize this; rather you want to avoid spending your cash on other things such as dividends (withdrawals or distributions) or purchasing equipment. That’s where a Statement of Cash Flows is beneficial … it shows you where you cash is going and helps minimize overspending.

For unprofitable companies, the most common issue is that cash goes out to pay for current operating expenses, of course. Sales of $1 million does little good if it cost $1.2 million in direct materials, wages and overhead. That’s where a good cash-flow budget can help you see the problem before it becomes a problem.

+ Question: My cash at end of period matches my balance sheet but my cash at beginning does not – Any idea why not?

Tom: Not really except that there’s an error in the calculation somewhere. Your professional accountant can help you track that down.

+ Question: You showed all receivables, including payroll tax and sales tax payable decreasing. Isn’t that unrealistic if sales and profits are strong? I know it is just an illustration, but it doesn’t seem to match the real world.

Tom: It appears we’re mixing metaphors here -> receivables are an asset and payroll tax and sales taxes payable are liabilities so the two are opposite. So it is quite common for accounts receivable to go down -> creating cash -> and then the cash be spent on paying off current liabilities (such as accounts payable and taxes payable). This happens mostly during a stable or decreasing sales period.

The flip side, during periods of rapidly increasing sales, you could expect an increase in receivables as well as liabilities which is the exact opposite of what I illustrated. The full illustration of the Statement of Cash Flows, which I used, was one such example taken from a real company.

And note, net income can increase on lower sales, especially if a company sheds marginally profitable work. So sales and “profits” are not necessarily in lock step with each other. So, yes, both match the real world. Course there are a whole bunch of potential variations on the same theme.

+ Question: So a “loss” of cash due to paying down a loan is not necessarily a bad thing unless it gets in the way of other current obligations.

Tom: Absolutely and a great question. First thing we should protect is our current ratio (current assets / current liabilities) and second is our days’ cash on hand (which should be 30+ and can be estimated by dividing annual sales by 365 and then multiplying by 30 – not precise definition but close enough for most of us).

I have worked with a number of folks who are (least were) debt averse. They would take all their cash and focus on paying down their non-current liabilities without considering their current liabilities. Then they’d get in trouble when adversity hits without any cash to compensate.

So IF one has a good current ratio (2:1 is standard) and enough cash on hand (30 days) THEN any cash in excess of the 30 days may be used to reduce non-current liabilities (noting that the current portion includes the next 12 months of note payable) and that would typically be a good thing.

+ Question: What time period should we use for our Statement of Cash Flows?

Tom: The Statement of Cash Flows is (or should be) one of the financial statements and included just as often as financials are received. I strongly advocate that to be monthly for a number of reasons but some prepare it quarterly.

To read more on this click on this article, Why Net Income Doesn’t Mean Cash

Hope this helps.

Tom

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When we decide to really begin selling, some of us spend time “creating demand for capacity we don’t have.” That’s a rookie mistake resulting in lots of quotes and little business. It also raises risks as we expand our product/service away from our competence zone.

Other owners deliver jobs to customers thinking that is a sales call. It’s not. Or we do customer service activity all day such as pricing or checking on jobs. What should we do? We should sell something to someone. How? Make a sales call.

So, what’s a sales call? A sales call is being in front of a new customer asking for new business; or being in front of an old customer asking for new business. It’s always about asking for new business. It’s never about getting a repeat order, delivering a price or servicing an account. Those things are nice but only asking for new business moves you forward.

Okay, but doesn’t that reduce us to only price competition? Well, everything being equal, price is always the determining factor. Therefore, never let everything be equal. The best way you do that is to develop a “focus.”

Al Ries, says in his classic marketing book, “Focus” that you must be the world’s largest something. I agree. Al’s book is a classic. It uses what are now outdated examples but the principles are perfect for our kinds of businesses.

Pish-posh. How can we be the world’s largest anything? We can be the world’s largest specialty pizza restaurant serving downtown Charleston, West Virginia. Or we can be the world’s largest provider of K-6 home-based educational material in the northeast United States or the country’s largest circus printer who prints exclusively for carnivals, fairs and circuses.

Whatever business you choose, the concept of “world’s largest” provides focus. And focus is everything – it clearly defines our market area, the prospects within the market, equipment we need, the skills our workers need, our specific location, the hours we are open, the way we are organized – in short, our focus is the reason people buy from us instead of the guy down the street.

Begin With Where We Are

Our focus begins with our location even in this Internet age. First sell where you are, not where you’re not. Most of us don’t really have a target market because we never defined it. The reason we haven’t defined it is because we’re too afraid we will lose business if someone outside of our target market wants to buy from us.

Recently a fellow who started a landscaping business told me he had two days a week of regular maintenance (lawn mowing) and a day or so of project work each week and needed more work but was extremely busy. Of course he was. He was taking customers anywhere in the 650+ square mile county.

We focused his territory to the three zip codes. Then we defined the profile of folks who were most likely to buy. He defined a homeowner over 65 with a house valued at $150k or more. We then did a database search and found 2,000+ suspects who fit this profile in the three zip codes. How many weekly contracts did he need to hit capacity? He needed about 30.

Lesson one: sell where you are; not where you’re not. Once you have proven the market isn’t large enough then expand but only after you’ve covered your immediate area.

Lesson two: to focus in a target market requires an active selling effort. Make sure you have one.

How have you done with your focus over the years? Here’s a way to see. Plot your largest customers on a map. If they are scattered all over the place, then it means, for the most part, they came to us, we didn’t go to them. Or they were near us years ago, moved away and continue to buy from us.

What should we do? Begin focusing on our piece of real estate. Set a goal to capture all the business where we are before diffusing our efforts into where we are not and into what we don’t know (expansion).

I’m not saying don’t work with people outside these focus areas. If they want to buy from you, then okay doke. I am saying not to spend time and effort selling over there when your advantage is to sell the same thing right here.

Tom Crouser

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Why Be a C? Why be a C corporation, that is? That’s my question. The answer I most often hear is “because my accountant said I would pay less in taxes.” While no one is thrilled about paying taxes, I want you to go beyond that answer to understand why you may pay fewer taxes. I also want you to review your decision yearly because circumstances change.

The following will sound a lot like tax advice – it’s not. My advice is to seek a qualified tax professional and, further, to actively participate with the decisions that are made. That’s the same thing you would do with your doctor if you had a dread disease. So, the following is not meant to be tax advice – it is meant to encourage you to participate with your tax professional in your financial decisions.

This is not to say that there are not legitimate reasons for being a C – it is to say that most companies we see are S corps or LLCs. And, for that many folks of our size and type to be S corps, well, I think that if you are not, you need to know why you aren’t.

Let’s first understand the basic differences between the C corporation (C corp.) and S corporation (S corp.). Their names were each taken from the section of the federal tax code under which they were created. (There’s also a T corporation – but that’s rarely used.)

On the surface, it’s almost a no-brainer. The C corp. will pay two levels of income tax – first a corporate income tax on earnings and then the stockholders pay personal income tax when they take the money out in either wages or dividends. The S corp. generally passes its taxable income or loss directly through to the owner, avoiding the double taxation.

Specifically, with a C corp., the first $50,000 of net income is taxed at 15%, the next $25,000 at 25%, the next $25,000 at 34%, and the rates go up from there. Then any wages or dividends paid to the owners are taxed again at the personal rate – 10% (very low income) to 35% (2011 rates). Therefore any wages or dividends flowing out to the owner will be taxed at a higher rate within a C corp. than an “S” corp. because of the combined corporate plus personal rates. And to add insult to injury, dividends are not tax deductible to the corporation; instead they are a distribution.

Contrast that to an S corp., which is also known as a “pass through” entity. The overall effect is the corporation is taxed similar to a partnership. While you file a corporate tax return, the income passes through to the personal tax returns of the owners to be taxed at the personal rate and avoiding the corporate tax add-on.

So why wouldn’t everyone want to be an S corp.? Well, for one, it’s not always available – for instance you can’t be within New Hampshire or Washington, DC and possibly other states. If you are in that situation, well, read no more. The rest doesn’t apply to you. Additionally, one reason not to be an S corp. might be your state tax situation. The way states tax an S corp. varies widely – from favorable to very unfavorable so state taxes are a key.

Start-Up

If you were without a lot of outside earnings and starting a new corporation, then a C corp. might be right because you would expect to have losses in the early years. An advantage to the C corp. is that these losses can be accumulated and offset income in later years. If you were an S corp. in this scenario, the losses would pass to the owner who wouldn’t be able to offset them against other income (unless there was income outside the business) and they would be lost (even bad things sometimes have value).

And, it is reasoned, once earnings do begin – then the corporation could be switched to an S corp. with one level of income taxes. Problem I find most commonly here is that lots of folks elect the C corp. scenario and never review it again.

You are not an S corporation until you apply and receive an acceptance letter by the IRS (no exceptions). To make the election you have to file within 2½ months before you start the business or 2½ months after the tax year for an ongoing corporation. If you miss the date you have to wait a year. The election is effective until terminated. Also an S corporation that was once a C corporation may be subject to one or more of three separate taxes (e.g., the “built-in gains” tax). This rule is an exception to the general rule that S corporations are not subject to tax.

Okay, but there is another start-up scenario. Let’s say one made a lot of money in a printing company and started a pizza place where losses were expected the first few years. Well, here’s a good reason to start as an S corp. since the losses in the pizza business would pass through to the owners and be offset against earnings from printing.

Note that losses taken cannot exceed your basis in the corporation – original capital plus income less losses – and can also be affected by loans and other transactions.

In this case, one would start as an S and remain an S, at least through the early through middle-aged years of the business.

Growth

Many reason that growing companies don’t take money out of the business – instead they allow the money to be taxed at the lower corporate levels and then reinvest the money into plant and equipment to expand. So, the theory goes, remain a C corp., pay the one lower corporate income tax and then reinvest the earnings into plant and equipment. That’s what many advise and it could be a great strategy.

But, often it is bad execution of a good theory. I don’t see it being done this way. We take out the money as salary, dividends or jacked-up rent and then borrow money based on our increased earnings to pay for expansion accomplishing both aims – taking more money out plus expansion – at least until we crash. Rarely does smaller business self-finance capital expenditures although we should.

Some professionals advise to remain a C corp. and retain the earnings because you pay a lower tax rate. A situation in Montana is an extreme example of this rationale. Our friend “hated to pay taxes.” His accountant hated it also. So, he remained a C corp. so his tax rate would be lower and not take the money out of the corporation. Three problems with this theory; first, just pilling up the money within a corporation (above and beyond current ratio needs) and not doing anything with it for the business or the family doesn’t do either the business or the family much good. It is a poor stewardship of assets.

Second problem is that if there is not a valid reason to retain earnings the IRS can treat it as a failure to distribute to the stockholders and could result in interest, penalties, and legal action to distribute in order to tax the retained earnings as dividends. Takes a lot to trigger this but it can be done.

Third problem, and what I see most often, is at some point we always take the money out. Maybe not this year, but eventually we do. Our Montana friend is facing this reality as he now contemplates selling the business. He complains that he can’t sell the business because he would have too much tax to pay.

Montana can certainly minimize his immediate cash outlay on taxes, but he can’t avoid them all together unless he doesn’t make money. Let’s not get carried away here. Paying income taxes is a good thing. It shows you make more than you spend. Paying excessive income taxes as Montana ends up doing is the bad thing.

Taking Over the World

If you were building up a war chest to take over the world, then properly done, a C corp. would be a good vehicle. You could earn money, pay only the corporate income tax, which would be lower than the personal amount, and have more money left over to buy other companies. Unfortunately, I’ve seen this happen only once. My opinion: more good theory, bad practice. Why? This only works IF you keep the money in the business and do not intent to take it out. I rarely run into owners who really do this.

Transitioning

Many times a C corp. is a good device for business transitions and this is where we see it used the most. Generally if mom and pop own 99 shares and junior owns 1, then the stock of mom and pop could be repurchased over time reducing it to 0 shares for mom and pop and 1 share for junior – or 100% of the corporation. Don’t do this without proper legal and tax advice.

Why Not to be an S Corporation

Here are some other reasons people advise not to be an S corp. with my comments.

+ Only eligible shareholders can receive S corp. stock and cannot have more than 75 shareholders. No problem in our businesses. Never ran into a small business with 10 stockholders, let alone 75 and the stock ownership thing applies mainly to trusts, pension plans, etc. – not to us normal folks. Worry about this during transition when you are rich and famous.

+ Estate planning is more complicated with an S corp. Don’t do it that way. Select, train and install your successor in your lifetime as Dr. León Danco says and transfer the business to the next generation when you retire, not when you die.

+ Fewer tax-free fringe benefits are available for shareholder-employees of S corp. than C’s.
And there is not full deductibility of personal health insurance premiums (although this may be changing). I have never seen this fact weigh heavily enough to make the difference in corporate status.

+ Medical dental reimbursement plan for pre-tax reimbursement of non-covered medical expenses are not available in S corp. Other benefits can also be structured this way including relevant education costs, group term life ($50,000), and employer-provided vehicles. This could be a reason for being a C corp. given a special situation. The Medical Reimbursement Plan allows the company to pay all of the employees’ medical expenses and are 100% tax deductible and not income for the employees. Problem is it must be applied to all employees. This might end up costing the business owner more than if they paid for their own family’s medical expenses with after tax dollars.

+ Deductible life insurance premium in C corp. Limited to $50,000 term that’s not available to S corp. Haven’t seen this as being a factor either.

+ Deductibility of key person disability insurance premiums are not available. I wouldn’t want to deduct in the first place since if you do, then benefits are taxable income to the individual shareholder. Better to pay taxes when you are healthy than when you are disabled.

+ Greater deductibility of retirement plan contributions, up to the lesser of $40,000 or 100% of income (SIMPLE plans limited to $7,000, and other S corporation retirement plans (SARSEPs and SEP-IRAs) limited to the lesser of $11,000 or 15%). (Note: rules may have changed on this.) Applies, but this is where the calculator really has to come out – and remember these benefits change frequently. All the more reason to have your status reviewed annually.

+ Aggressive tax planning opportunities for those with consistent annual surplus earnings of $100,000 or more (this amount includes retirement contributions). Okay, here would be a reason I would buy. Unfortunately it happens to few of the businesses that I see who are C corps.

+ Non-resident aliens cannot own S corp. shares. I have never seen this affect anyone although I am sure that somewhere it must.

+ Employee stock ownership plans are not available to S corporations; ESOPs can be used after 1997, but some of their tax advantages are not available to S corporations. Well, I would never advise you do this in the first place with our sizes of businesses.

+ Taxes are paid on income regardless of whether profit is distributed to the owners. True, but every S corporation I have ever seen distributes a dividend to cover the owners’ taxes. More often, someone remains a C corp. and pays income taxes on their salary while the corporation doesn’t make money. That’s the situation I see most often.

+ Division of wages and profits in S corp. causes audits. Yes, but same can be said of C corps. In an S corp., red flags are raised if you pay yourself a salary of $10,000 and have dividends of $100,000 for instance. This is a favorite audit area for the IRS and is says you are avoiding social security taxes, etc. So, just pay yourself a fair wage for the job you do and take the rest out in dividends. The reverse happens in C corps. Taxman says the salary is too high making corporate net income zero and thus avoiding corporate income taxes. Can’t avoid the possible audit either way, so pay yourself a fair salary and take the rest out in dividends (leaving enough working capital so the business can survive).

If you dream of turning your business into a big company, the C corporation structure is the best way to attract investors. Also if you are attracting institutional investors, the C corp. doesn’t saddle tax-exempt inventors with taxable pass-through profits. If you are truly worried about this in your business, then you’re reading the wrong advice column. I just don’t see this in small business. I say worry about the C structure when it is apparent that it will happen.

Tax Breaks: Sometime special tax incentives are available for C corporations. In some states being in a development zone will qualify a company for tax breaks but only if they are C corps. Good reason, but one must make sure that the tax breaks outweigh the cost of the C corporation. Your professional accountant should be reviewing this on a yearly basis with you.

Conclusion

I’m not saying you shouldn’t be a C corp. I am not even claiming that everything in this article is factual – although I believe it is. I am saying that there should be a specific reason for you to be a C corp. or an S corp. or an LLC and those reasons change over time.

And it is you, who should know the reason why and be able to articulate it in general terms. Otherwise, you may just be doing something this year just like it was done last year, just like we did the year before that. So review your status every year because it changes every year

Finally, as a post script, S corp. profits are not subject to self-employment tax, so there is a potential tax savings over doing business as a sole proprietor. Any salary paid to owners will be subject to social security tax but profits that pass through are viewed more as a return on investment and are not subject to social security tax (a.k.a. self-employment tax). But that’s a subject you need to chat with your professional accountant about.

Hope this helps.

Tom Crouser

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* Eliminations: from the total count, I removed schools, colleges, government offices, membership and religious organizations, social service entities and US Post Offices to obtain a net estimate of commercial business entities in the state. Understand this is probably MORE than the total number of businesses in WV since this data is location sensitive and one business may have more than one location. Actual tax data would be more accurate, however that was not available to me. Further, I note that eliminations amount to 22% or about 1 in 5 of the gross number of mailable business entities.

From this, the following data by number of employees** was found:

Employee size breakout totals more than the gross total due to duplications which I did not eliminate.

Tom Crouser

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Tom replied: You will need to work with your accountant to rename your accounts so that READERS of your financial statements (which usually means your Banker) can understand them. Specifically, I see a problem with your statement, “…in my financials the name of Current portion Long term debt is Long Term Liabilities.” That’s because it means the exact opposite.

Specifically, current is anything that turns into cash or uses cash in the next twelve months. Non-current (older verbiage calls this long-term) means anything that turns into cash or uses cash BEYOND twelve months. So, to name your “current portion of long term debt” as “Long Term Liabilities” is technically incorrect and needs to be changed.

Reader went on to write: I will be speaking with my CPA to see exactly how he wants me to peruse the renaming of my accounts.

Tom added: Your chart of accounts belongs to the company, not the CPA. Fact it, since it is the representation of management as to the financial condition of the business, the naming decisions belong to you, not the CPA. Now certainly the CPA can advise and assist because there are certain accounts that should be maintained for tax purposes (usually specific payroll tax accounts) but in the big picture … the accountant serves the business not the other way around.

Now the CPA certainly should have input for specific purposes (such as maintaining certain accounts usually for tax purposes). But they should rely on the owner to tell them what is important in this type of business (example: keeping paper separate from shop supplies). However, I know in reality what happens is the printer relies on the accountant who doesn’t know what the printer needs, so they plug in a chart of accounts based on some other business they’ve dealt with at some point and it may or may not be that representative.

That’s why we publish a recommended chart of accounts for small press and digital printers – because so many folks face this problem. For more info on our 2012 Chart of Accounts, $50, Click Here.

This chart has evolved based on working with hundreds of printing companies for over twenty-five years. It also is similar to the format used by NAQP for surveys although more detailed as required of a chart vs. a survey.

So, this document is our advice to the accountant as well as the owners as to what is important … and it’s done in such a way that the info may be used in BUDGETING. Example is splitting digital expenses – copying for some – into direct materials or click costs and overhead or basic rental of the equipment.

Hope this helps.

Tom Crouser

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Larry, a Delaware printer called me (304-541-3714) last Friday and was surprised when I answered. He had read my offers to chat but didn’t really believe them. Nonetheless, he told me of his self-diagnosed problem: he couldn’t find time to sell. Hum. Listen to what he said from my side and see if you agree with my take on his real issue.

Larry had just cut his staff to five; two workers, himself, his wife and father. Previously, there were eight and one-half people doing $500k in sales. That’s a very low $59k per employee. A couple years prior, he borrowed $100,000 to keep the business afloat. That’s dwindled away now.

The big challenge as he saw it was the sales drop which is not unusual these days. What was unusual was the reason: he moved the shop four years ago to be closer to his home. And while he planned to do a lot of selling in the new location, he mainly fiddled with ideas on how to market and sell without actually doing them.

To free Larry up for his sales efforts, his wife “ran the shop,” but she doesn’t oversee production. Fact is no one does. That falls to the press operator who is a “disruptive force” and has little to no people skills.

Oh yes, it wasn’t Larry’s idea to cut people; rather that came from the wife and father and he was looking for support from me. Larry’s plan now was to really begin selling this time.

Here’s my take.

The one key employee not performing is Larry. He reminded me of Steven Covey’s story in the “Seven Habits of Effective People” about the farmer who realizes in September that he forgot to plant in the spring. So, he tries to rush Mother Nature’s process with exhortations and overtime which never works that well.

Larry fiddled while Rome burned. Instead of reducing staff when he had time, he waited until the cash was so low he had no other choice. Instead of selling when he had time, he played marketing. It’s late in the game now.

His first task is to get to a net cash positive, or at least neutral, situation and then sell. That requires budgeting and organizing. Lucky for him, there are ways that can be effective in even the smallest of shops but that begins with organizing Larry’s time. In short, he must make time to sell and not find it. That’s accomplished by organizing what he does into time blocks and dedicating time to selling.

Say it can’t be done in a small shop? Sure it can. Begin by asking why one can’t sell three mornings a week. As obstacles are uncovered, handle them. In other assignments I found a printer who had to be in the shop to price certain jobs. That was solved by simplifying pricing and trained the wife to do it. In another, the college student who did deliveries needed the owner’s car from ten am until two pm keeping the owner from going out. Why? The student wanted to work then. He was replaced with another student who would work the hours needed. In another case, the CSR worked from 5 am to 1 pm because that’s what he wanted. Seriously, I’m not making any of this up. This was solved with a simple statement, “Joe, beginning the first of the month I need you to work from 8 am to 5 pm. Any questions?” Point is: organize around functions, not people.

Once done, progress can be made. But I don’t know if Larry is up to it. He’s put up with the attitude of the press operator for years. He’s fiddled with marketing without selling anything to anyone. I also got the impression Larry didn’t like what I said. Nonetheless, I hope he gets help. Otherwise, the business will crash and burn because Larry needs help in making changes. If you have a special situation, give me a call. I’m nice even when I have bad news. I promise.
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Reach Tom direct at (304) 541-3714 or message tom@crouser.com. Connect on Facebook and LinkedIn and follow my business tweets at www.twitter.com/tomcrouser Tom is Senior Contributing Editor of Quick Printing magazine and principal of Crouser & Associates, Inc., 4710 Chimney Drive, Charleston, WV 25302, www.crouser.com call (304) 965-7100. Or call Tom direct on his cell at (304) 541-3714.

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