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Small Business Finances 101: How to Profit

We finish this introduction to business finances by discussing the payoff for all your hard work – profit! In particular, we dive into how to use your business’ profits to get paid. Unless you’re independently wealthy, you probably need to extract profit from your company to pay your bills and live your life. Like many of the important things in life, you have options. In this case, you have to decide how to structure your business and how to tap into profit while creating the smallest tax obligation. Your particular circumstances will help determine the best type of business entity to use, and you should, of course, seek formal advice from a trusted accountant or lawyer.

Structuring Your Business

Your choice of the type of business entity to adopt will greatly influence the amount of time and work you’ll have to expend administering the business. A small business set up as a sole proprietorship is certainly easier to run than a limited liability company (LLC) or C-Corporation, but the latter give you all sorts of protections or tax breaks not otherwise available.

The five most popular business structures are:

  1. Sole proprietorship: A simple structure in which you are the sole owner of your small business. You file your taxes on your personal return, as there is no separation between you and your business. That means you have unlimited personal liability for your business’ debts, putting your personal assets are at risk. It’s also harder to get a business loan for a sole proprietorship.
  2. Partnership: This is much like a sole proprietorship, except it involves at least two owners. Once again, you file your taxes on a personal return and you have unlimited personal liability. You share the business’ profits proportionally with your partners, so it’s a good idea to ensure they are trustworthy.
  3. LLC: A separate entity that provides liability protection but not separate tax filings unless you chose to file as a corporation. It is easier to set up and run than is a C-Corp. However, it’s harder to get investors, since you can’t sell shares. Also, you can’t pay yourself a salary, although there are other ways to get money out of the LLC.
  4. S-Corp: Recognized in most states, its similar to an LLC except it can issue shares and can pay wages to shareholders while avoiding corporate taxation. The S-Corp requires more paperwork than does the LLC, and you are limited to 100 shareholders.
  5. C-Corp: A corporation is the most difficult to set up, as it requires its own set of books and separate tax filings. It’s the most professional approach to business, with limited liability and no limits on the number of shareholders. C-Corps provide many tax deductions and benefits not available elsewhere.

Extracting Money

Assuming you are running your business in order to make a profit, the question remains how to extract money from the business to pay yourself for your time and effort. Here are several options:

  1. Salary: You fill out a W-2 and pay yourself a salary, minus any withholding taxes. It’s simple, but not tax-efficient for a corporate entity.
  2. Dividend: A corporation can pay a dividend to shareholders. Any part of the dividend that is a return of capital, rather than profit, is not taxable. The IRS looks dimly on huge dividends.
  3. Shareholder loan: You can borrow money from your company, but if it’s at a below-market interest rate, you might be liable for gift or dividend taxes.
  4. Owner’s draw: Cash available only to sole proprietors or partners, this money is not taxed at the company level. The money must eventually be repaid to the company.

Clearly, the way you structure your business has profound implications for your after-tax wealth. Consult with a professional before deciding the best ways to take advantage of your business profits. If you need tools to grow profits through a maintained budget, check out our Business Budget Smart Sheet. This tool helps you stay on track so you can reach profitability sooner!

How Your Assets May Not Be Working As Hard As You Are

Why A Cash Flow Loan is Better Than Collateral for Business

Assets are the things your business owns. They include short-term ones, such as accounts receivable, cash, and inventory, and long-term ones, such as plant and equipment, intellectual property and goodwill. A business’s job is to convert assets into revenues and profits. If you are not fully leveraging your assets to help your small business grow and thrive, you could be missing out on profits.

There are two major ways that assets can be put to work by your business.

  1. Cash Flow Generation: Whether you are a merchandising company selling inventory, a manufacturer turning raw materials into finished products, or a service-oriented company relying on office space or equipment, you are using assets to generate revenue. The cash flow generated from your business assets can be put to work as the basis for obtaining a loan from an alternative lender. While banks look only at credit ratings, alternative lenders are usually much more interested in daily cash flows and lend based on healthy flows. A loan means working capital to pay down more expensive debts, purchase equipment, increase inventory purchases, expand operations, acquire a competitor or otherwise leverage your revenues so that the additional profits exceed the modest interest costs.
  2. Collateral: Another way to make your business assets work is to use them as collateral. Some lenders, often called factors, will make a loan collateralized by your fixed assets, such as plant and equipment, or backed by your accounts receivable or inventory. In an A/R loan, the factor advances you about 70 to 80 percent of the invoices it accepts, and then pays you the remainder, minus a financial fee, when the invoices are paid. This speeds up your business cycle by allowing you to purchase more inventory faster. It also relieves you of the headache of trying to collect from people or companies who are overdue. You can also sell your A/R for a fixed price to a collection agency.

Comparing the Two Methods

Both of these methods deliver capital to grow your small business, but there are advantages to cash flow generation instead of leveraging assets as collateral.

When you use assets as collateral in factoring, it puts pressure on your sales margins due to the fees you are charged when you pledge assets or the loss you take by selling assets. Also, if you sell your A/R, you could alienate your customers if they start being contacted repeatedly by a collections agency that is unknown to them.

In general, taking out a loan for cash flow generation is the better deal. Rather than tying up your main assets or, in the case of collections agencies, even selling them, you keep your business assets and maintain control. You also get a full sum of money rather than a percentage advance to use as you see fit, and you avoid the financial fees of factors. As long as you have daily cash flow and a solid plan, the profits generated from the additional inventory, expansion, or other project made possible by your loan will be a permanent gain that will let you pay down the loan comfortably. Now that’s putting your money to work!

If you’re ready to try cash flow generation, IOU Financial is a great starting point to find out what a loan can do for your business. You can work with a Small Business Loan Consultant to take you through every step of the process, and we approve 85 percent of applications we receive, including many people turned down by banks. Our base requirements are that you own at least 80 percent of the business, have been in business a year or longer, make 10 or more deposits per month, and have annual revenue of at least $100,000. To get started, give us a call at 866-217-8564.

 

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