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New Business Formation

Thinking of starting a new business? – Congratulations!

I have been involved with starting two businesses in the past 15 years, so I understand the combination of excitement, concern, and stress you are probably experiencing. And you have good reason to be concerned. Only one in five businesses continues after the first few years. Why do so many businesses stop operating soon after opening? Many times it was because the owner did not think through the finances. My Firm can help you with your financial issues in two ways: We can help you to develop a financial plan and analyze whether it is realistic; and we can advise you about the type of entity under which you should operate, given existing tax laws and considering legal protections.

Are your Financial Plans Attainable and Realistic -- Do they Generate Sufficient Profits and Cash Flows for your financial needs?

One of the key reasons why businesses fail is that the owner does not adequately assess the financing profits, cash flow, and financing needs of their new business. New business owners tend to err towards too much optimism. They believe in themselves and/or their product or service, and they want to start the business. They reason that because their idea is good, and if they sacrifice and work hard, the business will be successful. If you feel this way, that's healthy for a new business owner -- but only if the finances make sense. Good ideas, hard work and sacrifice can help, but if the expected profitability and cash flows are not attainable using realistic assumptions, you could be one of the majority of start-up businesses that fail.

Using a business advisor such as The Firm of James E Blowers, CPA to help you to prepare documents which shows you and prospective lenders and investors your financial plans is important for two reasons. First, we have the expertise to help you to prepare the budgets and other documents that you, prospective lenders and investors will find useful to make conclusions about the feasibility of your plans. Second, we will help you to address important issues and their costs that you may not have thought of. For example, how will your prospective customers know about you? Do you need initial costs associated with marketing your product or service? Do you need to do a marketing study, and will that require outside costs? These are issues that you may not consider without the advice of a business advisor such as my Firm.

Unless you have a business background, you will need a business advisor with my experience to help you to address the following financial documents:

  1. You need to identify and list the "up-front" costs you will need to incur even before you begin to operate. This includes determining the assets you must purchase before opening. This can include:
    • Identify the fixed assets you need to use to operate. This includes equipment, vehicles, and perhaps purchasing and improving buildings prior to occupancy. (Idea: can you negotiate some of the financing with the vendors?)
    • You may need to stock inventory prior to opening. (Idea: can you negotiate some of the financing with the vendors?)
    • You may need to pay fees to governmental agencies to operate.
    • You may need to incur soft costs such as advertising, hiring, recruiting, and training employees.
    • Finally, budget the OOPS factor -- paying for expenditures that no one thought of.
  2. You need to decide on the amount of cash you need when you start to operate. You need to cover any temporary cash flow shortages. For example, will your business collect cash/credit cards at the time of sale, or will you sell products or services on account? If you will sell on account, what is the expected collection of such sales? For example, your business will need to pay employees within 15 days. Will the business receive enough cash from sales to pay wages, vendors and lenders in the beginning months? My Firm can help you to identify and realistically address such issues.
  3. Owners will probably need to commit money to start the business. If you plan to obtain financing, you typically need to invest at least 10% of the cost to start the business before the lender will consider your loan request.
  4. You should budget your expected sales and expenses -- by month, for at least the first year. Why? Even if you expect to be profitable for the year, you need to identify if your business will use more cash than it deposits in certain months. If you plan the shortages in your budget and request adequate financing to cover those months, you will have a better chance of getting financing for those months, versus finding out about the temporary cash shortages and then trying to finance the shortages. See managing your cash flow to see the importance of managing your cash flow. You should budget as many years as you need to see when your business will earn acceptable profits and make distributions to owners, given the assumptions you use. Typically, the number of years that new businesses budget is 3 years.
  5. As you prepare the sales and expense budgets, you will need to make certain assumptions that are key to calculating sales and expense amounts. You should document those assumptions. You and the professional advisor should use spreadsheets and create formulas to calculate sales and expenses, so you can easily make changes to your budget if assumptions change.
  6. You need to "convert" the sales and expense budgets to show your business's cash flows. This includes showing the timing differences of recording sales when earned v. when collected; and recording expenses when incurred v. when paid. Also, you need to show the cash inflows from non-sales, such as proceeds from loans or investors; and cash outflows to repay loans and to distribute monies to owners. For some businesses, the net profit and cash flow can be quite different on a monthly basis. Both you and a prospective lender or investor need to know your cash flows as much as you need to know sales growth and profits. (You can only buy groceries with cash, not profits!)
  7. If you need to obtain financing from a lender or investor, you will need to put all of these documents together into a presentation that will be useful to them. To be useful, the presentation should be in a format that they can easily follow to assess whether your business has the financial ability to safely repay their loan plus interest. I can help you to accomplish this in a way that prospective lenders and investors will find useful for them to make their decision about whether to finance or invest in your business. See seeking financing for more information about obtaining financing, and my experience in this area.

Depending on the size of your business, we will look for opportunities to refer you to agencies such as the New York Small Business Development Center, which can help you with some of the documentation at a fraction of our cost. We will continue to work with them as they prepare documentation, so that you can feel reasonably sure that you will have a cohesive presentation that the bank will find usable and professional looking.

What Type of Entity Should you Operate As?

Deciding on the type of entity is important for both tax laws, and for protection from legal liabilities. Making the wrong decision can cost you thousands of dollars in taxes each year!

There are basically four types of taxable entities available to for-profit businesses: A Sole proprietorship, Partnership, S corporation, and C corporation. You may have also heard about a Limited Liability Company (LLC). For tax purposes, LLC's are generally reported on partnership tax returns. You can also be a Single Member LLC, but it is treated as a Sole proprietorship for tax reporting.

If you operate as an LLC, S corporation, or a C corporation, generally you are sheltered from legal liability, unless you personally sign a loan agreement or other document to accept personal liability. Also, if you operate as a professional, you may be held personally liable for your negligence, even if you are an LLC (or LLP). We will work with you and your attorney to address the legal aspect of the type of entity before you decide on the entity under which you would like to operate.

There are benefits and disadvantages to each type of entity, depending on the number of owners, fringe benefits, whether you are a professional, whether you employ other persons, whether you plan to operate in multiple states, and more. It is impossible to explain all the factors here. When I hear about your particular circumstances, I can advise you about the best choices. Then, we can follow-up with your attorney, so you can make an informed decision about the type of entity under which your business will operate. It is wise for you to spend a relatively small amount up front in order to save much more in taxes and other headaches in the future.

Other Financial Assistance We can offer to New Businesses

Other ways in which we can help you set up your new business:

  1. We can help you to select the accounting software so you receive useful financial reports you need to monitor your business's profitability, cash flows, and continued growth in value. Receiving these reports is key to you achieving your cash goals, both currently and in the future when you dispose of your interest in the business. See useful reports for more information regarding using useful financial reports to measure your progress towards achieving your financial goals.

  2. Establish financial ratios and other metrics to help you to identify favorable or unfavorable trends in profitability, solvency (ability to continue), cash flows, and your return on your investment.
  3. Establish billing and collection procedures to maximize your cash flow and avoid unexpected cash shortages.

  4. Establish procedures to monitor and control costs.

  5. Setup a home office (if you are not incorporated), so you can maximize your tax deductions.

  6. Prepare and file to tax authorities, your business's application for your Federal Employer Identification Number, and the type of entity.

  7. We can help you by reading any purchase agreement, partnership agreement, or other agreements that could have a significant impact on your business's finances, now or in the future. I do not take the place of an attorney. However, I frequently bring up issues that businesses and their attorneys should address before the owners sign key agreements. Also, sometimes an owner or attorney will not realize the financial impact of a provision in the agreement. An agreement that omits key issues (such as disability of an owner), or whose wording is vague or conflicting can result in unhappy owners, loss in cash and other value, and costly lawsuits. My purpose for reading the agreements is to identify potential financial or other issues to avoid these undesired outcomes.

Action Plan

You may have initially look at developing financial plans for lenders or other investors. Hopefully you can see that you need to make sure your financial plans will generate sufficient profits and cash flows to make your business successful. We can help you to develop your financial plan and help you to decide if the plans are realistic, to avoid the common pitfalls that many new business owners make when starting their new venture. Also, if your financial plans are realistic, we can help you to present a loan or investment proposal that lenders and investors can use to make their decision whether to lend or invest in your business.

Once you decide that the financial plans of your business generate sufficient profits and cash flows, now and in the future, we can help you to decide on the type of entity under which you will operate.

  

If you would like to learn more about how we can help you to start your new business, please call Jim Blowers for an appointment. The initial consultation is free!

Let us help you succeed by getting your new business off to a good strong start. Please complete the form below to learn more about our New Business Formation Services.

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