Almost half of American businesses fail in the first five years.
Most entrepreneurs have heard this axiom, and it is supported by the latest statistical data from the U.S. Small Business Administration and the U.S. Bureau of Labor.
So, how do business owners ensure they are among the 56 percent who make it past the five-year mark, the 35 percent who make it to 10 years, or the 20 percent who survive at least 20 years?
Area certified public accountants and tax attorneys agree on several key points upon which business owners can focus.
Most of it comes down to disciplined practices and realistic planning.
Cash-flow management, knowing what’s coming up and preparing for it, is vital, they say.
“You don’t go to school — unless you’re an accountant — and talk about cash-flow statements and what all that means,” said Christian Vaught, a CPA and partner at Mauldin Vaught PLLC in Fayetteville.
And yet, “cash flow is king,” he said.
David Nixon, managing partner at Nixon Law firm in Springdale, is an inactive CPA and an attorney for more than three decades. He works primarily with businesses and individuals on financial issues, including bankruptcy.
“New businesses are often undercapitalized,” Nixon said. “I’ve been at this a while, and a good rule of thumb is: Whatever you think it will cost, in money and in time, double or triple it. Then you’ll be in the ballpark.”
A key ingredient to success is often a “dose of healthy skepticism,” Vaught said.
“People start businesses because they’re passionate about something, which is great because it drives it forward. But it’s really important to have that skepticism, where you’re more reasonable in your projections of who’s actually going to come through the door, so you can spend accordingly,” Vaught said.
One way entrepreneurs restrict their cash flow is by overinvesting on inventory, said Michael Mauldin, also a CPA and partner at Mauldin Vaught.
“They’ll get excited and overspend right from the start. They buy too much or go out and buy the nicest things, and before too long customers didn’t come like they thought they would, so, automatically, they’re behind,” Mauldin said.
The money, which could have been applied elsewhere, is just sitting there, he added.
Plan to Pay
Another major component of cash-flow management is systematic planning for required expenses.
“One of the biggest mistakes that companies make is that they’ll go out and hire employees, they’ll start to ring sales up and they’ll not track payroll taxes that are due. They won’t track sales taxes as closely as they should,” Mauldin said. “For small-business owners, we often encourage them to take the time and literally segregate that money into a separate account, so it’s almost out of sight, out of mind, so that it’ll be ready for when those payroll taxes are due the following month.”
As an attorney, Nixon often represents clients who can’t pay their taxes. He said one of the worst taxes to owe is payroll tax, because after it is taken out of an employee’s check the person holding the cash is acting as a trustee for the federal government, and the consequences of not turning it over at the appropriate time can be serious.
Still, Nixon said, there are company owners who leave it to chance.
“Once money starts getting tight for a business, some owners might see that [payroll tax] money in their account and think, ‘I’ll just pay a bill or two out of this and then make it up next month.’ And before they know it they are in over their heads,” Nixon said. He has represented small-business owners who owed upward of $1 million in payroll taxes.
Sales tax is another bill that businesses don’t want to get behind on, Nixon said, “because the state will shut you down.”
Many times, missed or incomplete sales tax payments stem from a lack of proper record-keeping, which should be a top priority for business owners, the experts say.
“Save receipts, invoices and other support that show income and expenses,” even if the expenses were paid using a personal credit card, said Don Fitzpatrick, a CPA at Beall Barclay & Co. PLC in Rogers.
“If you have just been audited by the Internal Revenue Service or your state taxing authority, and they want to see your records for those business expenses that you have reported on your tax return, if you don’t have records to prove what you spent, then you are out of luck,” Fitzpatrick said. “The IRS will disallow all of your expenses that you can’t prove.”
Also, without good records, entrepreneurs don’t understand the finances of their own companies.
“We have a lot of people that come in, and they don’t know if they’re making money or not,” said Vaught, who specializes in advising small businesses. “They’re living off of what’s in the bank account without having a plan for where it goes, because they didn’t invest up-front, before they opened their doors, to get their accounting system and their [point of sale] system set up correctly, in order to receive good, timely and accurate information.”
This, in turn, inhibits their ability to make informed decisions for the business, he added. “Do I have the money to invest in a new piece of equipment? I don’t know. I haven’t done my books for six months.
“To operate a business, these are things you really have to be on top of. Otherwise, you’re operating in the dark a little bit,” Vaught said.
Startups often cannot afford in-house legal and accounting help. At the same time, the experts agree that tax law is nuanced, and most entrepreneurs would benefit from talking to a professional.
“If you’re starting a business for the first time, I recommend you at least talk to an accountant, the earlier the better, even if it’s just asking a few questions,” Nixon said.
“If you’re going to have employees and a storefront, it’s probably time to call a lawyer,” he added. “Ask some questions, take an hour to lay out the game plan. Then, pay me for my time, and we’re done. You may never see me again.”
Nixon said a business owner might rack up more like five billable hours once there is a problem — when somebody falls in the owner’s store and sues, or when somebody breaches a contract.
“A lot can be avoided if you plan on the front end,” he said. It’s important, for example to establish partners’ responsibilities, who is in control of various parts of the business, how the money is distributed and what happens if the venture or the partnership go south.
Another key decision made early on is business entity type.
“Many business owners expect to have a loss in the first year and then are disappointed to learn that they will not be able to deduct the loss, based on the type of entity they have chosen and their debt structure,” said Kendal Powers, CPA at Frost PLLC in Fayetteville. “Others form an LLC (limited liability company) and make a profit, only to learn that they will be hit with a large self-employment tax liability on their earnings. Clients sometimes assume that the attorney who helped them incorporate has filed the S corporation election, and if that was not communicated explicitly to the attorney, the company will be taxed as a C corporation.
“It is very important to hire not only a good attorney when you are starting a business, but also to involve a CPA who specializes in small business taxation,” Powers said.
Devil in the Details
Business owners might not know, for example, that they must self-assess and pay use tax on items purchased over the internet.
“We’re seeing a lot of businesses — and new businesses especially — having all these back taxes because the state’s getting really aggressive on use tax,” Mauldin said.
“The two greatest enemies of a small business are litigation and taxes. There is far too much at stake when it comes to your small business to risk trying to go it alone,” Fitzpatrick said. “Without proper, professional guidance, the courts or government can drive you into bankruptcy.”
On the other hand, Vaught recommends seeking information wherever it’s available, through independent research, a small business development center or an advisement source like Fayetteville firm Startup Junkie Consulting.
“Someone in the industry, someone that’s run a similar business, a CPA that can help navigate the laws — their input is a very important piece of your puzzle. It doesn’t have to be a paid professional like us,” Vaught said.
“Business owners also need to know themselves,” he added. “Is accounting something I’m willing to do, not just to save money, but do it and do it well? Or is my time better spent out doing the sales and the things I’m passionate about?”
If the answer is the latter, it’s time to hire some help, Vaught said.