Q: I use an accounting firm that also offers tax preparation services. Why do I need to learn anything about finance?
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A: You need to learn more than you think you do. Let me explain why by examining some aspects of your business that require an ability to understand your accounting.
Taxes
The most important is taxes. This involves more than simply retaining a receipt for every deductible expense. You must make decisions on the timing of taxes.
If you have a tax payment due by January 15, you should know whether it’s deductible in the year in which it is due or whether it can be deducted in the year in which it is paid.
If the tax is large, paying early will give you a larger deduction this year (but a smaller deduction the following year).
Develop tax-based strategies. If you plan to buy a major piece of equipment, paying two years’ worth of moveable expenses in one year will “buffer” the expense of that purchase. This is particularly important if the equipment has an allowable depreciation rate of only 20% per year.
Cash Flow
You need financial acumen for many decisions, such as whether to pay up front or finance a major buy. That requires knowledge of both cash flow and profit projections. You seldom have enough cash on hand. Paying up front might be unwise. If a machine has 5-year depreciation, your cash flow might look better if you financed and deducted one fifth (plus the interest) each year.
You should always know some details of your cash flow. If you’re using a contractor for your payroll, you should know when paychecks will be issued and when payroll taxes must be submitted. Even if you’re involved in either process, your bank account will be, and you must have the funds at hand.
Borrowing
If you plan to borrow money for expansion someday, or to seek outside investors, you need a strong understanding of all financial aspects of your business.
A lender or investor will demand that information to evaluate their potential risk.
When you meet with them, their grilling will be aggressive. You can bring financial information and your accountant to the meeting, but your investors expect you to answer all the questions. They want to be sure you know where the money comes from and where it goes.
Understand Your Finances
Lastly (perhaps most critically), you cannot make good business decisions if you don’t understand your finances. Your business is a collection of products, services and skilled employees.
That’s important to the community, but for you it is a river of cash from which you hope to divert enough to feed, clothe and house your family. If you can’t see the river clearly, you won’t avoid the traps and sandbars. Your business will be at higher risk of sinking. Most simply said: your business is its finances.
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If you want to improve your understanding of all this or any other business issue, call (831) 621-3735 or go to www.santacruzscore.org and get a free SCORE mentor. SCORE offers free small business counseling and low cost workshops.