How to develop the next generation of leaders

It’s unfortunately very common that many businesses do not have any sort of leadership development program in place. Typically, that’s because most owners are too involved in the business to work on the business, so strategic initiatives like leadership development are an afterthought.

However, businesses that do have leadership development programs tend to also have formal governance and a more sophisticated management team. These factors often translate into companies with higher employee retention rates and better financial performance.

Smart Business spoke with Steven E. Staugaitis, a director at Kreischer Miller, about how to set up a leadership development program.

What are the most critical aspects of a leadership development program?

A central piece of it is identifying the right candidates, which requires flexibility. How leadership is aligned today — its skills and knowledge — may not be what the business environment demands in the future. Running a business is so dynamic that what a company thinks it needs today could be very different than what it actually needs five to 10 years from now.

Family businesses that are intentional about their family legacy tend to have good leadership development plans. They’ll identify family members who have certain qualifications and help support their growth through a variety of activities. For example, companies might rotate their leadership candidate through different roles and departments in the company, assist them to obtain advanced degrees or send them to specific training. Mentoring relationships with people inside or outside the company is also a common practice.

How should companies choose candidates for leadership development?

It’s the tendency of companies to choose leadership candidates based on strong technical competencies. But when looking for a future leader, it is also critically important that they have the right leadership skills. As the leader of any organization, you are expected to motivate and encourage people, and hold them accountable for their performance. Leadership is more about managing people and driving a strategic vision rather than being a good technician.

What do companies tend to get wrong when it comes to leadership development?

The most common problem is that companies don’t do anything or wait too long to start. Leadership is not a switch that gets flipped just because someone’s title has changed. It takes years to develop internal candidates — a five-to-seven-year runway should be expected when grooming an internal candidate for a leadership position. And for those companies that don’t have internal candidates, it can take the better part of a year or more to hire an outside candidate for a key position.

In any transition, there is always risk in the process. When companies invest in people to make them better, they also need to empower these candidates along the way and give them a chance to implement some of their ideas. If not, there’s a good chance that they will take their skills and go somewhere else.

What are the differences between developing leaders and hiring them from the outside?

Often an internal candidate is perceived as less threatening to the rest of the organization than bringing in an outsider since they are known within the organization and also by their clients and customers. Promoting someone from within sends the message that there are similar opportunities for other people in the company.

Interviewing outside candidates for leadership positions can be a little like dating. Candidates and companies are on their best behavior. It’s not until someone is hired that their nuances and true personalities are revealed. Taking your time to thoroughly vet outside candidates for critical positions is a good idea.

Regardless of whether a leadership position is filled by an internal or external candidate, the process can’t begin early enough. It may seem overwhelming at times, but at least starting with something, even if it’s something small, is a far better alternative than do nothing at all.

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How the Wayfair decision is playing out in the U.S. market

It has been several months since the U.S. Supreme Court rendered its historic decision in the South Dakota v. Wayfair Inc. case and taxpayers are still grappling with its implications.

Prior to the Wayfair decision, a business had to have physical contact with a state before becoming subject to its sales tax collection and reporting requirements. As a result of Wayfair, physical presence was no longer required to establish a substantial contact with a taxing state for sales tax. The new sales tax nexus standard is now commonly referred to as economic nexus.

“The reality is that the U.S. Supreme Court changed the sales tax compliance landscape overnight, because states were very quick to get on board and adopt an economic nexus standard that was identical to the South Dakota standard at issue in Wayfair,” says Thomas M. Frascella, J.D., director of tax strategies at Kreischer Miller.

Smart Business spoke with Frascella about the Wayfair decision and how the change is affecting both businesses and states’ sales tax collection practices.

What has changed because of the Wayfair decision and who is affected?

As a result of the Wayfair decision, approximately 36 states now consider a remote seller to be subject to a state’s sales tax rules when the remote seller has either a specific number of transactions with residents in that state or a specified dollar amount of sales in that state. Generally, $100,000 of sales or 200 transactions will subject an out-of-state business to a sales tax collection responsibility in states adopting an economic nexus standard.

The decision affects many businesses, especially those that operate from a single location but use multiple channels, such as marketplace facilitators or internal e-commerce platforms, to generate sales. Often these businesses do not have either the personnel or financial resources to comply with these new requirements and must now navigate this new reality. Although there have been attempts at the federal level to pass legislation to minimize the impact to small businesses by narrowing the nexus generating activities, these attempts have failed and businesses remain subject to the requirements of each and every state.

How are businesses responding to the law change?

Businesses will now need to determine how to move forward. Some may decide to take a wait-and-see approach to the matter and do nothing, opting instead to see how aggressive states become in identifying and pursuing remote businesses for sales tax. Other businesses will be more proactive in managing their new filing requirements and begin to explore solutions. These solutions will most certainly require some type of technology investment to enable a business to charge the proper sales tax, as well as collect and remit that tax to the appropriate state and local taxing jurisdictions.

Businesses should take the time to understand the states where they have met or exceeded state economic nexus thresholds for sales tax purposes to determine if they have an issue. It will also allow a business to assess their potential exposure if they have nexus and decide to do nothing.

How are states’ collection practices changing?

States are likely developing discovery tactics and collection practices to identify out-of-state businesses with sales tax nexus. Once a state identifies an out-of-state business that should have been collecting and remitting sales tax, it will pursue recovery of past due sales tax with penalty and interest, which could be difficult for a business to recover from customers.

Many states are operating in a deficit and need to find new sources of revenue. It is no longer a ‘if they find me,’ but rather a ‘when they find me’ scenario. No business should consider themselves too small to pursue. Businesses need to develop an action plan to avoid being caught holding the liability for a tax that could have been passed along to customers in the normal course of business.

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How an M&A deal can go sideways and what to do about it

The 2018 M&A deal environment in the Philadelphia area was particularly strong across the middle market. And while the pace might not match the previous year, considerable deal activity is expected through 2019. Buyers and sellers looking to capitalize on the market should be mindful of the mistakes that can derail a deal, and how those mistakes can be avoided.

Smart Business spoke with Richard Snyder, director of audit and accounting at Kreischer Miller, about M&A pitfalls and what preparation ahead of negotiations can help buyers and sellers avoid them.

What tends to trip up M&A deals?

Any time the buyer doubts the quality of the information provided, there is a high risk of negative consequences. These first show as a loss in value and can eventually lead to the loss of a transaction. This may arise when information and documents requested by the buyer are slow to be provided, the seller cannot provide adequate explanations about certain details requested by the buyer, or information provided by the seller differs from the underlying support and details that come out of the due diligence process.

Complex issues such as customer concentrations, ongoing litigation, and environmental remediation may pose significant risks to a company that a buyer cannot overcome. These and others may impact the purchase price or may be too great a risk for a buyer, which results in the buyer walking away from the deal.

What happens if a deal goes sideways?

A great deal of resources are utilized by both the buyer and seller in a transaction. If a deal goes sideways, both lose the time and resources they put into the transaction. The seller’s management team loses valuable time that could have been spent on the operation of its business. Additionally, sellers may spend a considerable amount of money on professional services and other fees as part of the deal process. The business may continue to be for sale and a failed sale may make it less attractive in the marketplace.

A buyer may lose the lost opportunity cost to pursue other deals in addition to professional fees and other costs. However, it is important to note that the cost of failed mergers and acquisitions may far outweigh the costs spent on a potential transaction and walking away if the transaction is not right for both sides.

How can buyers and sellers increase their chances of success?

Sellers need to be prepared for the sale of their business by making sure they have a full understanding of the sale process and the necessary resources. Their books and records should reflect complete and accurate financial reporting and the owners should have a full understanding of risks that could affect the company’s valuation and potential salability. Understanding the latter gives the seller the opportunity to be upfront with a buyer and address potential issues before the sale process begins, which could offset any negative impact on a transaction.

On the buy side, it’s always important to have a sound due diligence process, and an understanding of the deal environment and the target’s industry and regulatory environment. Accurate valuations are also important in determining an appropriate purchase price, as well as having a plan for the integration of the business post transaction.

Who should be a part of the buyer and seller deal teams?

Sellers should have a good transaction attorney, accountant and possibly an investment banker. The investment banker will assist in preparing marketing information, taking the business to market and finding prospective buyers. It’s always a good idea to have an experienced accountant and attorney on the business advisory team. These advisers should not only understand the company, its industry and the deal market, but they should also have transaction experience.

Buyers often have internal teams that can run a financial analysis and conduct due diligence on a target. However, some buyers also work with an outside team on the financial due diligence.

There are multiple reasons deals don’t go through, but a significant obstacle is a lack of preparation. Having good advisers on both sides who are experienced and understand M&A is very important to a successful deal.

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The benefits of an independent Chief Information Security Officer

Cyber and information security readiness is high on the agenda of all executives. However, the ability of these executives to address their ongoing cyber security needs varies drastically.

The majority of larger organizations have an internal Chief Information Officer (CIO) who leads all IT-related efforts, including cyber and information security. These CIOs rely on a Chief Information Security Officer (CISO) to manage their internal and external cyber security teams. These teams comprise professionals, both internal and external, who address issues ranging from ongoing system configuration and monitoring to development and upkeep of information security and privacy policies.

Most middle-market firms, especially smaller ones, do not have a CIO. Some do not even have an IT manager on staff and thus rely heavily on their outside IT providers for ongoing maintenance and support of their systems. In these organizations, given the limited nature of internal resources, cyber and information security issues tend to be dealt with in less than optimum fashion.

Smart Business spoke with Sassan Hejazi, director of technology solutions at Kreischer Miller, about how middle-market companies can implement cyber security protocols in an effective fashion.

Why might an outside IT provider be ill-equipped to fully protect an organization?

Many executives of middle-market organizations equate cyber and information security with basic IT management, and as such assume their IT providers are performing all the necessary security-related activities as part of their normal IT support contract. Most IT service contracts, however, only cover basic security-related matters, such as virus protection and general-purpose application version updates, and do not get into reviewing each client’s unique business information management and classification processes and applicable cyber risk issues.

Who should companies work with to create and maintain a cyber security program?

An independent CISO provider has a team and the right tools in place to assist an organization and its internal and external IT teams with the same type of service that larger organizations use, but at a fraction of the cost. The independent CISO will be responsible to act as the subject matter expert in areas such as conducting risk assessments, identifying gaps, recommending remediation solutions, assisting with development and delivery of updated policies and procedures, and delivering applicable training solutions. The independent CISO team will also be responsible for conducting periodic validations, such as penetration tests or war-game exercises, to test and validate defenses and assist the organization and its internal and external IT teams with lessons learned and applicable improvement efforts.

This kind of a relationship is successful only if there is an empowered representative from the IT team and another from non-IT within the organization able and willing to participate and take ownership of the cyber security process. The IT provider representative will ideally be the lead system engineer assigned to the client organization who is familiar with their overall systems and acts as the IT support advocate for the client organization. The client organization will also need to have at least one individual, preferably two — one IT if there is an internal IT team or person, and one non-IT, usually highest-level finance officer, such as the controller or CFO — who will act as the organization’s cyber advocate.

How should executives stay connected to the cyber security process?

The independent CISO team will be working closely with all involved parties in establishing an effective and ongoing cyber and information security program. This will require periodic meetings to review, plan and execute cyber-related activities as well as quarterly or semi-annual executive meetings to update the executive team regarding the latest development in the field and what steps could be taken to address such concerns. This approach will lead to the implementation of the core components of an effective cyber and information security enterprise risk management program as practiced by larger firms, but one that has been adjusted to fit the needs of a middle-market organization.

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How to put yourself and your business in the best tax position this year

On December 22, 2017, the country experienced the most sweeping tax legislation since the Tax Reform Act of 1986. The Tax Cuts and Jobs Act is a comprehensive tax overhaul dramatically changing the rules for tax years beginning before 2026.

“With such a vast change to the law of taxation, tax season is so much more than just ‘getting your taxes done,’” says Lisa Pileggi, CPA, director of tax strategies at Kreischer Miller. “Preparation is key, requiring you and your tax adviser to communicate early and often. This communication should include your adviser obtaining an understanding of your current tax situation in order to determine how the new law will affect you.”

Smart Business spoke with Pileggi about the new tax laws and how businesses and business owners can ensure they’re prepared to comply with them come tax time.

At a high level, what can we expect from the new tax law?

The Act includes the suspension of personal deductions, provides for an increase to the standard deduction and the child tax credit, imposes limitations to the state and local tax deduction, a temporary reduction to the medical expense threshold, as well as the imposition of new income tax rates and brackets, among many other changes. The legislation also provides a new deduction for non-corporate taxpayers with qualified business income from pass-through entities.

The legislation enacted by Congress favorably impacts businesses by reducing the corporate rate to 21 percent. Additionally, other provisions positively impacting businesses include the elimination of the alternative minimum tax and the expansion of capital expensing and depreciation. The new law also provides favorable reforms to small business owners.

How can businesses prepare for the changes?

Businesses and owners should talk with their tax adviser now to learn what impact the new laws might have. Some of the questions that should be answered include:

  1. Will converting to another entity type provide an overall tax benefit?
  2. Should the business examine ways in which to assist employees for unreimbursed business expenses?
  3. Have wage withholdings been examined and are adjustments needed before year-end?
  4. Have year-end gifts been evaluated to take advantage of the annual exclusion?
  5. Should the business evaluate a capital expenditure plan before year-end to maximize the enhanced accelerated depreciation?
  6. Has the tax basis in pass-through entities and total estimated business losses been reviewed to determine if losses will be deductible?
  7. Is there a need to review compensation amounts to analyze if adjustments are needed to minimize the effective tax rate?

What else should businesses and business owners do to be ready come tax time?

Identifying the technical aspects of tax season is undeniably crucial, however that is not the only area that demands consideration. The manner in which tax season is executed also deserves attention. Both tax practitioners and clients have expectations with regard to the manner in which the relationship is managed, as well as the timetable to which deliverables are completed. Conversations should take place to discuss the expectations of both parties and determine a mutually agreed upon timeline to hold one another accountable.

A tax adviser wants a client that communicates regularly and involves them in their day-to-day business when appropriate. A client wants an adviser that is proactive, creative and effective. When advisers and owners work collaboratively, these goals can be met.

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What’s driving M&A deals and how companies can capitalize on the activity

Merger and acquisition (M&A) activity was very strong in 2017 and 2018 has been even more robust. Most closely held businesses have substantially enhanced their balance sheets since the recession and are now experiencing record years for profits and revenue. Many also have excess working capital that can be deployed to acquire competitors and/or key suppliers.

Smart Business spoke with David E. Shaffer, CPA, director of audit and accounting at Kreischer Miller, to get a breakdown of M&A activity in the market, what’s driving it, who is realizing success and why, and how business owners can capitalize on the opportunity.

What are some of the factors driving the increase in M&A activity?

  • Interest rates are still very low, by historical standards. As a result, the cost of capital remains low. Since many believe that interest rates will continue to rise, the cost of this capital could become more expensive in the future.
  • Company balance sheets seem much stronger than they have been historically and owners are actively looking for opportunities to enhance their return on invested capital. There are really only four choices to deploy excess capital: pay a dividend to shareholders, buy back stock, invest in internal expansion, or merge with or acquire another business.
  • Many privately-held businesses lack a succession plan. As such, aging owners may be forced to look at third-party acquisitions.
  • Private equity firms are actively looking for targets to purchase and established companies to sell. During the first half of 2018, private equity completed 2,247 deals with an aggregate transaction value of $263.9 billion.
  • The Tax Cuts and Jobs Act increased expected 2018 cash flows for C-Corporations and most S-Corporations. So, owners are looking for the best opportunities to put this additional capital to work.
  • Technology continues to improve efficiency and profits. Plus, companies with unique technology are especially attractive to buyers.
  • Business friendly legislation and policy changes are reducing the risk to potential buyers.
  • M&A can be an attractive option for owners who want to expand geographically, diversify their customer base, or expand their products or services.

What are business owners currently experiencing in M&A deals?

  • Purchase prices are increasing over historical levels. Larger, well-managed companies are selling at multiples in excess of seven times EBITDA.
  • Companies with unique technologies are fetching higher prices. Anything that provides a buyer with a competitive advantage over other suppliers is highly valued.
  • In most transactions, either the buyer or the seller (or the bank) is procuring a quality of earnings report. These reports are prepared by an independent professional and provide an objective assessment of the accuracy and quality of historical earnings and assets, as well as the sustainability of earnings in the future.
  • Deals that are from a ‘book’ or have gone to multiple companies for potential purchase usually do not get purchased by private companies or families. Instead, a private equity firm will typically acquire these companies, since they are more willing to pay a higher multiple and assume a greater degree of risk.
  • Banks are looking to finance these transactions. Many companies have satisfied their equipment and IT needs, so there is not a lot of loan growth and banks are seeking other ways to deploy their cash in order to maintain profitability.

Successful acquisitions require effective integration, accurate valuation in determining the purchase price, sound due diligence, and a clear understanding of the cash flow risks.

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Know your customer and know your competitors

There are many factors that go into growing your business — acquisitions, product or service development and enhancement, geographical expansion, strategic partnerships and more. But before you get to any of these strategies, you must first know your customers and your competition.

Smart Business spoke with Todd E. Crouthamel, CPA, director of audit and accounting at Kreischer Miller, about the importance of focusing on the customer experience and how it leads to success.

What does it mean to “know the customer?”

In order to know your customers, you have to understand who your customers are, what their needs are and what value you deliver to them. Most successful companies have a customer-centric culture. All of their team members are aware of their role in the customer experience and everyone is focused on making the customer experience the best. These are the companies that can often charge a premium for their products or services. Their customers are buying not only the product or service, but the experience from their first contact with the company through follow-up.

To truly understand your customers’ experiences, consider creating a customer experience map. It details every possible way that customers or prospects interact with your brand. It is focused on why, how, when and for how long they interact with you. It enables you to review all of your customer and prospect touch points, determine what they are expecting during that interaction (both technically and emotionally), and how their expectations are met or not met.

Once the customer experience has been mapped, you will have more information as to what the customers’ goals and feelings are for each interaction, and can revise your sales process to ensure that you are exceeding these expectations. Customer experience mapping should provide you with information to make informed improvements to customers’ experiences, leading to increased satisfaction and retention.

How is it that knowing competitors can translate to knowing customers better?

Competitors are often seen as enemies, but if you take the time to learn from them, you may end up stronger than them.

A healthy analysis of your competition is helpful when trying to grow your company. You should not obsess over your competition like you should over your customers, but rather you should know what they offer, to whom, how they deliver their product or service, and how they position themselves in your marketplace.

Useful information can also be found by knowing your competitors’ customers and prospects. If your target prospects are similar, knowing how your competitors reach these prospects can provide valuable insight into how you could be reaching the same potential customers.

It is equally important to understand how your competitors deliver value to their customers and why their customers chose them. What perceived value did customers see when they made the decision to work with the competitor and why do they continue to work with them? The answers to these questions should provide you with additional information to shape your customer offerings, better enable you to tell your story and demonstrate the value that you provide, and differentiate yourself to current and future prospects.

How should companies conduct this research and what should they do with it?

You do not need a spy kit to find the answers to most of these questions. A review of competitors’ websites as well as discussions with their current and former customers and industry participants should provide you with sufficient background to make a meaningful assessment.

To be successful over a long period of time, these key elements need to become part of the culture of an organization. These are not branding initiatives or business development exercises. Rather, these are about building a culture of customer-focused and competition-aware team members who understand their role in the customer experience and work to ensure that all customers are not just satisfied with their experience, but are delighted by it.

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How sales tax nexus, bolstered by the Wayfair decision, affects your business

Sales tax nexus is an area of the law that many businesses would prefer to believe does not affect them directly, though most are aware that the issue exists.

States have become increasingly aggressive in terms of audit techniques, enforcement of existing laws and the enactment of new laws to compel businesses to comply with sales tax collection and reporting requirements. And with the Supreme Court ruling in South Dakota v. Wayfair Inc., there is now a binding legal precedent emboldening states’ efforts.

Smart Business spoke with Thomas Frascella, director of Tax Strategies at Kreischer Miller, about sales tax nexus, how and when it applies, and what the Wayfair decision will mean for businesses.

How is sales tax applied to out-of-state sellers and what are the exceptions?

Most tangible personal property is subject to sales tax unless it is either excluded or exempt from sales tax. For decades, most states were fairly lenient about the collection of exemption certificates. Although state rules require that the exemption certificate be obtained at the time of the sale, most states had historically allowed taxpayers to collect exemption certificates long after the sale had already occurred. Presently, states are beginning to enforce the collection requirement on audit and assessing sales tax if the taxpayer cannot provide an exemption certificate coinciding with the date of the sale.

States are also beginning to more closely scrutinize transactions involving drop shipments. Drop shipments typically involve a scenario in which the seller has a manufacturer ship a product directly to the seller’s customer. Drop shipments can create a sales tax trap for the unwary. Generally, sales for resale are exempt transactions provided a valid exemption certificate has been granted to the appropriate party. In the case of a drop shipment, it is the sales tax nexus of the manufacturer making the delivery that will determine the appropriate state exemption certificate needed.

For example, Seller A is located in Pennsylvania and is not registered in any other state. The manufacturer is located in California and is making a delivery to Seller A’s customer in California. Seller A must provide the manufacturer with a California resale certificate. If Seller A cannot provide a valid California resale certificate, the manufacturer should collect sales tax because it delivered a product that it sold to a location in a state where it has nexus. Some states will allow sellers to use their home exemption certificate or a multistate certificate. Others will not, rendering an otherwise tax-exempt sale taxable.

What effect is the Wayfair decision expected to have on states’ sales tax collection?

The most significant development in the area of sales tax nexus is the U.S. Supreme Court’s decision in South Dakota v. Wayfair Inc. The Wayfair case involved legislation enacted by South Dakota to impose sales tax nexus on remote sellers. The legislation required out-of-state retailers with either 200 or more transactions or $100,000 in sales to residents of South Dakota to register for and collect South Dakota sales tax. Wayfair challenged the constitutionality of the law based on the court’s prior decision in Quill Corp. v. North Dakota, requiring a physical presence in a state to establish sales tax nexus. In a surprising decision, the Supreme Court sided with South Dakota and overturned the long-standing physical presence standard.

As a result of the Wayfair decision, a significant number of states have enacted similar legislation as the law enacted by South Dakota aimed at compelling remote businesses — businesses located outside state borders — to either begin to collect and remit sales tax or report purchases made by residents of states enacting such laws. To date, approximately 22 states have enacted legislation that adopts an economic nexus standard for sales tax purposes.

Today, remote sellers of all sizes that meet these economic thresholds could become subject to multistate sales tax reporting and collecting, and will need to deal with the impact on their businesses. The hope now is that Congress finally takes action to enact a national nexus standard for sales tax purposes that will provide consistency for businesses. Until that happens, businesses will be forced to understand the various state standards and assess the impact on their business.

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Business owners should keep tax implications in mind year-round

Business owners have a lot to think about during the year. Among their concerns are taxes. However, taxes often get the least amount of consideration, though they are arguably among the more important factors impacting their business.

“In a tax year marked by the newly enacted Tax Cuts and Jobs Act, it is vital that business owners recognize the importance of understanding their tax liability and how tax planning throughout the year can benefit them come filing season,” says Brian D. Kitchen, director of Tax Strategies at Kreischer Miller.

Smart Business spoke with Kitchen about the ways in which taxes could affect business decisions throughout the year.

What are some tax incentives business owners should keep in mind?

When business owners are made aware of certain tax incentives during the year, it provides their advisers with an opportunity to explain the benefits of such incentives. It also enables business owners to factor these tax savings into their current year tax calculations.

There are many tax incentives built into the Tax Cuts and Jobs Act for businesses in a variety of industries. These incentives are in the form of tax credits, which reduce tax liability dollar for dollar, and tax deductions, which reduce taxable income.

Some common tax credits include the Work Opportunity Tax Credit, which allows employers to claim a tax credit based on hiring a certain targeted group of individuals; and the research and development tax credit, which rewards companies that innovate and invest in new products and processes. The code also provides for immediate expensing of certain depreciable property, such as machinery and equipment. The new tax bill also introduces a 20 percent deduction on pass-through businesses.

It is important for a business owner to understand the substance and mechanics of the incentives in the new tax law as well as a host of other federal and state tax incentives, as planning might be needed to take full advantage of them.

How might estimated tax payments affect a business?

The income tax expenses of business owners are a cash flow item that requires attention, not only for budgetary reasons, but to mitigate potential interest and penalties on any underpayment of taxes. The IRS and many state and local governments require that estimated income taxes are paid during the year on income that is not subject to tax withholding. This is especially important for business owners of pass-through businesses, those being S-corporations and partnerships, as their pass-through income is not subject to tax withholding.

When the estimated taxes are calculated on a quarterly basis, business owners are able to readily understand the cash flow impact their tax expense has on their business. More importantly, in a year with a dramatic change in the tax code, quarterly tax projections provide business owners with a real-time understanding of how changes in the code impact their businesses.

Why should business owners keep their advisers informed throughout the year?

When advisers are able to meet and communicate with their clients throughout the year, it enables them to provide proactive advice that will not only affect owners’ businesses during the year, but will ultimately provide peace of mind and help prepare for their tax filing the following spring. This approach lessens the probability of surprises in the form of unexpected tax bills, enables a business owner to make more informed decisions where a tax incentive could be utilized and provides for a smoother compliance season as many tax-related items would already have been discussed throughout the prior year.

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The critical success factor within every company’s control

In working with so many private companies, accounting firms get to see it all — different companies, industries, sizes and definitely different performance. Through that experience, some commonalities can be found that directly impact performance, for better and for worse.

Smart Business spoke with Mario O. Vicari, CPA, director at Kreischer Miller, about the differences between top-performing and underperforming companies.

What are the factors that give the best indication of a company’s fitness?

Although there are many metrics one could consider in evaluating a company, there are two that really matter and they are related. The first is net margin, which is the percentage of net profit per dollar of sales. Think of it as how many pennies you keep for yourself for each dollar you sell from operating the business. This is a simple yet powerful concept. The second is the company’s return on invested capital, which expresses how the net margin relates to the amount of total capital deployed to generate the net profit.

Looking across many companies’ performance, most companies are somewhat better or worse than average in different degrees. However, there are very few private companies that have exceptional returns. These are the outliers — the top 5 percent of private companies.

While many factors affect performance, the common denominators among higher performing companies are:

  • They have absolute clarity about the customers, markets and opportunities that fit their business model, and have clear rules around customer acceptance, including the economics that are acceptable to them.
  • Having established rules around customer acceptance, they have the discipline to follow through on their strategy, which means that they will say no to opportunities that are not a fit.

What are the commonalities of underperforming companies?

Companies that are struggling and in need of a turnaround often have poor gross and net margins and low returns on invested capital. Looking into the details of their customer and product mix, often what is found is a hodgepodge of customer and product sales that are widely dispersed and unfocused. These bad results come from a lack of strategy and associated rules around customer acceptance. To these companies every sale is a good sale because they have no established business rules about their target customers and products, or in some cases they have rules but don’t follow them for the sake of getting the sale. This lack of focus and discipline results in low margins and returns. These decisions are often misguided by the belief that growing sales is the goal, whereas it ought to be growing profits.

What are the characteristics of companies that perform well?

In the better-run companies, it can be said that:

  • Everyone in the company knows the company’s focus and what customers they choose to serve.
  • They establish business rules for their sales and customer service people, including pricing, margin requirements, etc.
  • They have mechanisms in place for exceptions and approval, and clear guidance for when the company may vary from its norm. Exceptions have to be approved and are not the norm.
  • The leaders of the company don’t override and break the rules. They lead by example.
  • The company’s incentive programs are designed to reward behavior that is consistent with the company’s rules.

These companies have a point of view about new opportunities that most businesses don’t have, which is why they perform at such high levels. They know that the customer acceptance decision is a two way street and is not only up to the customer. They know that they have a choice about which customers and opportunities to pursue, and which ones to avoid. They know that they don’t have to work with everyone to be successful and have the discipline to say no when the opportunity is not a fit for their business model.

Insights Accounting & Consulting is brought to you by Kreischer Miller