Importance of financial forecasting

One of the main reasons for a small business failure is lack of planning of cash. A good forecasting mechanism increases business success chance and minimizes the failure risk. Small business owners must realize the importance of this tool to plan ahead in order to make their business successful.

A successful business owner relies on a forecast to develop a business strategy. In this global competitive environment, a business must adjust its strategy constantly. One way to address this competition is that owners/managers must predict what will happen tomorrow. Businesses who accurately forecast, advance ahead, while the ones that don’t, fall behind.

Budgeting is an essential part of a financial forecast; it is a mechanism to estimate future income and expense by utilizing and manipulating few variables. Different methods can be used to determine future income and expense. Predicting the future is not easy, which is why business owners sometimes seek professional help to prepare pro forma financial statements. These sets of statements are the financial plans for small business owners.

Why it is critical?

Financial forecasting is an important tool if you are applying for a business loan. It also plays a vital role if your business is cyclical, so you can overcome cash shortfalls and plan ahead accordingly to pay your vendors, rents, payroll and other business expenses.

If you are planning to introduce a new product, it allows you to construct a model of how your business might perform financially if certain strategies, events and plans are carried out.

How often should you prepare a financial forecast?

It depends on the circumstances of your business. Small businesses should prepare a financial plan quarterly or semi-annually. If you are having cash-flow issues, then preparing a financial forecast more often would be a better strategy. Likewise, if you are experiencing rapid growth, more frequent forecast strategy allows you to measure your performance more effectively and develop a plan to rectify any issues which could be critical in making your growth strategies successful.

Should you prepare a forecast yourself?

According to Morton J. Marcus, director of Indiana University’s Business Research Center, which provides forecasting services, “Most financial executives still rely on implicit forecasts they construct for themselves, using information they have gathered from a number of sources and working on an instinctive basis. But it is unlikely that they are looking at all of the variables. Using professional forecasts is really nothing more than prudent business behavior.” One of the reasons to hire an outsider is objectivity; there will be no emotions attached, whereas, an owner/executive might construct a forecast based on the assumptions with which he/she has some sentimental values.

For example, one of my clients had a dream to open up a restaurant so badly that he ignored all the warning signs. After discussing the idea with him and after introducing other cost factors which he disregarded, we found that the plan was not viable at that point and had to be revisited in future with a different location. As Marcus said, “models are based on past behavior. As conditions and behavior change, models must be revisited and modified”, with the help of a professional.

What is benchmarking and why is it important for my business?

In simple terms, benchmarking is a tool to compare business performance against the industry. It is one of the ways to judge what the best practices are and how you can improve your business process. For example, if the industry is earning 10% return on assets, while your business is earning only 6%, you can pin point the problem areas. However, it is important to know that when you use benchmarking data it should be relevant to your industry, business size and region. In other words, you should be comparing apples to apples. Achieving parity against the best in the industry may not always guarantee success.

Another factor you should consider when you use benchmarking data is how accurate the information is. This can be a difficult task given the data dynamics, sources of the data, sample size, timeliness and NAICS classification. A challenge business owners face is to which specific financial metrics should we compare and which ones are important to achieve the strategic goals. Another issue is how to measure non-financial metrics. Benchmarking techniques can be used both in service and product based businesses.

Benchmarking can result in frustration and failure if the business matter is not selected strategically. In order to appropriately select and prioritize benchmarking tasks, corporations need first to understand their critical success factors and business environment. This helps them identify their key business processes and drivers. The whole process of benchmarking should be aligned to the corporation’s mission, vision, values and strategy. All leading-edge corporations such as Xerox, DuPont, and HP use benchmarking as a valuable tool to improve their competitiveness and effectiveness. It is an integral part of their strategic planning.

In order to be a successful business you need to implement benchmarking effectively. It allows you to evaluate your business performance and ensure that your business is operating at an optimal level. Outside professionals can be engaged to streamline the whole process who will carefully select the relevant KPI’s for benchmarking critical to achieve your business objectives and strategic goals.

Salary or Dividend – Which One Is Better?

When tax planning for your next tax return, you may want to keep in mind whether to earn income through salary or dividends.

The owner or manager must determine the remuneration they wish to receive, and must therefore determine the optimal salary and dividend combination to maximize their cash flow. To avoid retroactive tax planning, it is best to connect with your accountant on this matter and they can advise which the best option is.

Salaries/bonuses and dividends are the most common methods of remunerating the owner/manager. Many owners provide themselves a payroll, just like their employees, and others may pay out dividends to themselves, or a mixture of the two. Below lists the differences of each:

Tax deductions

• Salary is subject to tax deductions and charges through the personal tax return. Dividends are paid out of the retained earnings of the company had have already been subject to corporate tax. A dividend tax credit is then given to the owner through their personal tax return which is equal to the taxes paid at corporate level.
• 
  
• Bonus should be paid out within 180 days of the fiscal year-end; otherwise it will be added back to the corporation income.

Income-splitting

• Advantage of dividend is to split income with family members who directly own the stocks in the corporation. Another advantage of dividend is that CRA does not do test the reasonability as in the case of salary.

Payroll deductions

• Earning a salary allows for providing pensionable earnings for CPP purposes and EI premiums, but both portions of CPP will need to be paid, both the employer and employee portions. On the other hand, dividends are not subject to these payroll deductions, as well as workers’ compensation and provincial payroll/health services.
• 
  

RRSPs

• A salary offers benefits in contribution to RRSP by gaining RRSP deduction room, and as a result, these investments come with creditor protection. Dividends do not exercise this benefit.
• 
  

When it comes to the time to filing taxes, working with your accountant will be your smartest decision. They will be able to calculate what would be the most beneficial combination of salary and dividends that results in the highest amount of cash left after taxes.

Small Business Deductions

Deduction and Tax credits available to private corporations

Owning a small business entitles you a Small Business Deduction on your active business income (ABI), reducing the amount of tax that your business might otherwise have to pay.

According to CRA, to qualify for the Small Business Deduction, a corporation has to be a Canadian-controlled private corporation (CCPC), which meets all the following conditions:

• it is a private corporation;
• it is a corporation that was resident in Canada and was either incorporated in Canada or resident in Canada from June 18, 1971, to the end of the tax year;
• it is not controlled directly or indirectly by one or more non-resident persons;
• it is not controlled directly or indirectly by one or more public corporations (other than a prescribed venture capital corporation, as defined in Regulation 6700);
• it is not controlled by a Canadian resident corporation that lists its shares on a designated stock exchange outside of Canada;
• it is not controlled directly or indirectly by any combination of persons described in the three previous conditions;
• if all of its shares that are owned by a non-resident person, by a public corporation (other than a prescribed venture capital corporation), or by a corporation with a class of shares listed on a designated stock exchange, were owned by one person, that person would not own sufficient shares to control the corporation; and
• no class of its shares of capital stock is listed on a designated stock exchange.

The small business deduction currently provides for an 11% to 15% (depending on which province you reside in) federal tax rate on a CCPC’s ABI. However, only a limited amount of income qualifies for this deduction. The current federal limit is $500,000.

Additional tax deductions

For additional tax credits on your Canadian small business, you can claim business-use-of-home expenses if you have a dedicated work space in your home to earn business income, as well if the work space is where you do more than 50% of your work. To calculate your business-use-of-home expenses, you will first need to calculate the area by square feet in your home that is used for business conduct. By using this percentage, you can claim costs that relates to your work space, such as electricity, heating, maintenance, cable, mortgage interest etc. (there are some limitations check with your professional accountant)

Are You an Employee or Subcontractor?

This is an important question to be aware of, especially for small businesses. Most people may think there are not many differences between the two; however, how things are carried out in the business and the potential outcome of tasks, make all the difference. It is important to know what employment status you hold, as there are different obligations for each.

Below lists the main differences between an employee and a subcontractor:

Control

• As an employee, you work under the business’ control; you are paid for the amount of time that is worked and that is set under an agreement, as well, you perform the duties of your position under specific working conditions. Subcontractors have more control. They have more freedom in the way work is completed and how long it takes, since they do not have anyone overseeing their activities. They also have the freedom to accept or refuse work. Subcontractors usually work independently within a defined framework.

Tools and Equipment

• Companies will either provide their employees of the necessary materials and equipment to carry out their tasks, or the employer will reimburse the costs that may have been incurred in regards to the use of these tools and materials. In the case of a subcontractor, they themselves are responsible for supplying their own materials and tools that will be utilized in carrying out their duties. They will also be responsible for the costs of repairs, insurance and maintenance to the tools and equipment.

 Opportunity for profit and chance for risk 

• An employee does not experience the chance of profit and the risk of loss. Since they do not have capital investment in the business and are not in a position to realize a business profit or loss, they do not experience change of investments. Due to more freedom that subcontractors hold and the fact that they hire and pay employees, there is more opportunity for risk and profit for these individuals. They are compensated by a flat fee and may incur a number of expenses while performing services.

Benefits & paid leave 

• A big advantage for employees is the benefits and paid leave that is included in their contract. They are able to participate in employee benefits such as vacation pay, health benefits, pension plans, etc. Subcontracts do not exercise this option; they don’t have any employee benefits and insurance policies such as disability insurance. 

If you are an employer looking to hire individuals for work, keep the above in mind. Subcontractors are an incentive to hire if one is looking to reduce costs or mitigate project risks. The employer does not have to contribute to CPP or EI for a subcontractor, like they do for an employee. Subcontractors are essential for business-to-business relationships. However, if you are looking for more of integration within your business, employees are the better choice since they are more involved in the business values and their work is an integral part of the business.

Take time when choosing what type of worker you would like to be, or if you are already currently employed, determine which employment status you hold: an employee or subcontractor. By defining which category you are positioned in, you are then able to analyze the advantages and disadvantages of each and make decisions accordingly.

Why do I have to pay tax by Installments?

Personal Installments

You have to pay tax by installments for the same reason that most people have tax withheld from their income throughout the year. If you earn income that has no tax withheld or does not have enough tax withheld for more than one year, you may have to pay tax by installments.

This can happen if you earn rental, investment, or self-employment income, certain pension payments, or income from more than one job.

Who has to pay?

If your net tax owing is more than $3,000 in 2014 and either in 2013 or 2012.

When payment are due?

For current year, payments are due on Mar 15, Jun 15, Sep 15 and Dec 15

Penalties

You may have to pay a penalty if your instrumental payments are late or less than the required amount. CRA apply this penalty only if your installment interest charges for 2014 are more than $1,000.

Corporations Installments

Corporations generally make monthly or quarterly payments called installments towards their tax liability. There are three options you can use to calculate the least amount of tax you have to pay in installments for the current tax year.

Monthly installment payments

You can calculate your monthly installment payments using one of the following options:

• Option 1 – One-twelfth of the estimated tax payable for the current tax year is due each month of the tax year;
• Option 2 – One-twelfth of the tax payable from the previous tax year is due each month of the current tax year;
• Option 3 – One-twelfth of the tax payable from the year before the previous tax year is due in each of the first two months of the current tax year. One-tenth of the difference between the tax for the previous tax year and the total of the first two payments is due in each of the remaining 10 months of the current tax year.

Are you eligible to make quarterly installment payments?

• A small CCPC is eligible to make quarterly installment payments if, at the time the payment is due:
  • - it has a perfect compliance history;
  • - it has claimed a small business deduction for the current or previous tax year;
  • - together with any associated corporations, for the current or previous tax year:
•                                     – it has taxable income of $500,000 or less; and
•                                     – it has taxable capital employed in Canada for the tax year of $10 million or less.

When you do not have to pay installments

Tax payable of $3,000 or less

You do not have to make installment payments on your federal taxes if the total of your taxes payable under Parts I, VI, VI.1, and XIII.1, determined before taking into consideration specified future tax consequences prior to the deduction of current-year refundable tax credits for either the current or previous year, is $3,000 or less [subsection 157(2.1)].

If your Part XII.3 tax is $3,000 or less in the current or previous year, you do not have to make installment payments on this tax.

Similarly, you do not have to make installment payments on your provincial or territorial taxes if the total of your provincial or territorial taxes for the current or previous year is $3,000 or less; however, you have to pay your taxes, if any, on your balance-due day.

New corporations

Except for Part XII.1 tax, you do not have to make installment payments for a new corporation until you have started your second year of operation. However, for your first year of operation, you have to pay any tax you owe on or before your balance-due day for that tax year.

This information is extracted from Canada Revenue Agency Website. For more information click following links

Personal tax installments
Corporation installments 

Improving Cash Flow Strategies

Cash Flow Importance

Why is cash flow so important for a business? A simple answer to this question is, without proper cash management no business can survive and resultantly leads to trouble with creditors and ultimately in bankruptcy. Therefore, it is safe to say that cash is the lifeblood of a business. A very popular saying is “cash is king” in every business.

It is important for a business to understand the requirement of its cash flow which allow in making wise investments and protecting the company’s future growth. How do you know that you have enough cash to survive?  Some of the strategies can be utilized to manage cash includes monitoring daily cash position, utilizing proper accounting techniques for receivable and payables, budgeting, cash forecasting, preparing monthly or even weekly cash flow for medium to large size businesses.

A well planned cash flow management will help a business to:

• - Maintain its liquidity to pay its debts and payable
• - Comply with bank covenants
• - Helping during the downturn time
• 
  

Warning Signs

• - No positive cash flow for several months
• - Receivables are over 60, 90 days
• - Payables are over 60+ days
• - Unable to pay yourself
• - Borrowing against credit cards
• - Inventory levels are going up
• - Dipping into your retirement savings plan to overcome the cash shortages
• - Home refinancing to meet routine expenses
• 
  

Tips to improve cash flow

• - Maintain your books regularly, invest in a proper accounting system
• - Utilize net 30 days option to pay your bills
• - Invoice regularly and collect them faster or offer some discount incentives so customers pay your bill faster
• - Maintain your inventory, don’t invest too much cash unless there is a strategic reason for that
• - Check your prices, a proper pricing strategy can be adopted to make sure that you are maintaining your sales
• - Strategically evaluate renting vs. leasing and/or buying vs. manufacturing options.

 

Most small businesses close their business doors after one year because they failed to manage or implement a proper cash management system.

CNC can help you to evaluate your cash-flow needs and implement a strategy to manage your cash flow effectively and efficiently which is critical for your business survival and growth.

Income Splitting with Minor Kids

One way to reduce your taxes is to split income with your family. This is one of the popular tax planning strategy. Under this strategy, you hire your children and pay them salary which is deductible to your business as long as wages are reasonable in relation to the services they have provided. CRA checks the reasonability of the amount in terms of what would you pay to an arm’s length party for similar job.

Some of the jobs that a kid can perform including:

-          Cleaning office

-          Washing automobile

-          Mailing letters

-          Products delivery

-          Data input

In some cases these expenses can be denied by CRA.  In one of Tax Court Case Bradley v The Queen, TCC 2006 500), CRA challenged the expenses. In 2001, Nancy Bradley, employed her daughter who was 8 year old and her son Mathew who was 12 years old. She paid them salary $2,000 and $5,000 respectively. Nancy claimed these payments as salary expenses on her taxes. CRA said these payments were not based on the duties they performed or the hours they worked and lastly, they are not reasonable, therefore, CRA denied these expenses. Nancy and kids said these are legit and payments were made however, judge ruled in the favor of CRA since mom had the control over funds withdrawal and kids did not have full control over the funds. So a lesson we learned is:

-          Payments should be reasonable

-          Work description should be in place ….. what they did

-          Working hours record should be maintained

-          A separate bank account should open under the kids name on which they should have a sole discretion to withdraw the funds

Foreign Income Verification Statement (Form T1135)

Canada Revenue Agency announced a change to form T1135 Foreign Income Verification Statement for taxation years ending after June 30, 2013. The purpose of this move is to crack down on international tax evasion and aggressive tax avoidance as laid out in the 2013 Economic Action Plan. Individuals, corporations, trusts, and certain partnerships, that, at any time during a year, own specified foreign investment property costing more than $100,000 must file a Form T1135 by the filing due-date of their income return . This applies even if the taxpayer has no tax payable during the year. If you own specified foreign property in excess of $100,000 and fail to file Form T1135, you could be subject to late filing penalties of $25 per day to a maximum of $2,500 per year. For more information read here

B.C. Early Childhood Tax Benefit

Budget 2014 proposes to introduce the B.C. early childhood tax benefit (BCECTB) as a tax-free monthly payment, effective April 1, 2015. Benefits from this program will be combined with the federal Canada Child Tax Benefit (CCTB) and the B.C. family bonus program into a single monthly payment.

The BCECTB provides a benefit of up to $55 per month per child under age 6. Benefits are based on the number of children in the family and the family's net income. The BCECTB will be reduced if the family's net income exceeds $100,000 and will be zero once the family's net income exceeds $150,000.

Complete budget www.gov.bc.ca/budgettaxchanges

Medical expenses for tax purposes

An individual may claim a medical expense tax credit for the amount determined by the formula in subsection 118.2(1) in Income Tax Act. Under the formula, the lowest tax rate percentage (15% for 2012) is multiplied by the total of two calculated amounts. The first calculated amount relates to medical expenses paid in respect of the individual, the individual’s spouse or common–law partner and children under 18 years of age. The second calculated amount relates to medical expenses paid in respect of other dependents of the individual.

Say for example, that you have incurred $3,000 in total eligible medical expenses and your total income on line 236 is $51,000 from all the sources so according to the formula:

Medical expenses                                                                         $3,000

Minus lesser of 3% of 51,000 or $2,109 (annual threshold)                  -1,530
Subtotal                                                                                     1,470

Allowable medical expenses credits 15% of 1,470 = $220.50    

                  

Subsection 118.2(2) describes the types of medical expenses that are eligible for the medical expense tax credit. Additional requirements for paragraphs 118.2(2)(m) and (n) are provided in sections 5700 and 5701 of the Regulations, respectively. If a particular expenditure is not described in subsection 118.2(2) (or does not satisfy the additional requirements in sections 5700 or 5701 of the Regulations, here paragraphs 118.2(2)(m) or (n) as applicable, are relevant), the expenditure is not eligible for purposes of claiming a medical expense tax credit, even though the expenditure may have been incurred for medical reasons.

Gluten-free food

The incremental cost of acquiring gluten-free food products compared to the cost of comparable non-gluten free food products may be eligible medical expenses under paragraph 118.2(2)(r). The cost must be incurred on behalf of a patient who has celiac disease and who has been certified in writing by a medical practitioner to be a person who, because of that disease, requires a gluten-free diet. 

Medical marihuana

If a patient is authorized to possess marihuana for medical purposes under the Marihuana Medical Access Regulations orsection 56 of the Controlled Drugs and Substances Act, the cost of the medical marihuana or marihuana seeds may qualify as medical expenses under paragraph 118.2(2)(u).

Cosmetic Procedures

An amount that may otherwise be an eligible medical expense described under subsection 118.2(2) may be denied pursuant to subsection 118.2(2.1) if the service was provided purely for cosmetic purposes. 

Receipts

Generally, all expenses claimed as eligible medical expenses must be supported by proper receipts. A receipt should indicate the purpose of the payment, the date of the payment, the patient for whom the payment was made and, if applicable, the audiologist, dentist, medical doctor, medical practitioner, nurse, occupational therapist, optometrist, pharmacist, physiotherapist, psychologist, or speech-language pathologist who prescribed the purchase or gave the service. A cancelled cheque is not acceptable as a substitute for a proper receipt. In addition to receipts, proof of payment or proof of support may be required in situations where an individual claims the medical expenses tax credit for amounts paid in respect of a dependant who is 18 years of age or older at the end of the year.

A complete list of eligible medical expenses is available on Canada Revenue website http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/ncm-tx/rtrn/cmpltng/ddctns/lns300-350/330/llwbl-eng.html