Why enterprise risk management is key to an effective growth strategy

For many owners the value of their business is the largest asset on their personal balance sheet.  As such, it is critically important to manage risk factors that could reduce opportunities and diminish value.

“Evaluating and addressing risk through an effective enterprise risk management process is fundamental to achieving a company’s goals”, says Stephen Christian, Managing Director of Kreischer Miller.

A growth strategy without addressing attendant risks may result in unexpected consequences which limit the chance of success.

Smart Business spoke with Christian regarding the importance of an enterprise risk management system for growing, privately held companies.

What is enterprise risk management?

Enterprise risk management (ERM) is most often defined as methods and processes used by organizations to manage risks related to the achievement of objectives. Risks come in many forms—geopolitical, financial, customer, supply chain, regulatory, litigation, rising costs and so on. Properly managing these risks will help to achieve desired goals.

What does risk management have to do with growth?

All companies that pursue growth take on risk—increasing headcount, adding equipment, entering into new markets, investing in new technology, dealing with new suppliers – all have attendant risks that should be anticipated, planned for and managed. If you omit risk factors from strategic planning, you will be more vulnerable to interruptions and road blocks to growth.

Isn’t this a public company issue?

Absolutely not. Public companies are often larger and more geographically dispersed, thus dependent on systems and processes to drive success. They generally have significant resources invested in evaluating and planning for risk factors that may impede success. Private companies, although perhaps not as large or sophisticated, operate in a fast-paced, complex and, more often than not, global marketplace.

We live in a new era of growing and diverse threats and obstacles to our businesses. All companies must protect their strategy and growth desires by effectively managing risk.

Who should be responsible?

Assuming you do not have a risk management department headed by a chief risk officer, most often this initiative is led by the COO or CFO.

Such a person is often in the best position to look across the organization and focus on the big picture.

This person in turn communicates with the CEO and/or board of directors. The leader of the initiative will have strategic interactions with key people throughout the organization to discuss potential risk factors and their possible impact on desired strategies.

How do you implement an effective ERM system?

First you need to understand the importance of such a system in achieving your goals and be committed to setting a tone at the top. Then assign leadership responsibility to the right person and clearly set forth the expectations for the initiative. The group or person charged with developing the ERM system will identify risks that could impact the business, assess their likelihood and magnitude and determine appropriate responses.

This process often involves scenario planning—what happens if costs go up, access to inventory from another country is interrupted or employment markets tighten. An often overlooked aspect of a successful ERM system is the need to periodically update your findings.  We live in a constantly changing world and these changes often impact the risk factors that can affect a successful business.

Companies need to be resilient and anticipate obstacles to growth and success. Don’t wait until it is too late to plan and make adjustments. The earlier you anticipate potential problems, the more alternatives you will have to navigate changes necessary to ensure you accomplish your goals. So as you plan your future growth strategies, you will be well served to make ERM an integral part of the plan. ●

Insights Accounting & Consulting is brought to you by Kreischer Miller

Three things you need to know about your lender

Now that the economy is showing some traction and the business environment is continuing to improve, business owners are looking at opportunities to expand their businesses, including hiring additional team members, purchasing new equipment and making acquisitions.

Such plans often require outside capital, and commercial banks can provide an affordable source of funds.

“The more that you know about your lender, the better your chances will be in securing business credit at favorable terms,” says Mark G. Metzler, CPA, CGMA, Director of Audit & Accounting at Kreischer Miller.

Smart Business spoke with Metzler on the three issues you need to know about lenders.

What are the key factors that lenders use in their decisions?

Lenders assess credit risk based upon factors including credit/payment history, income and overall financial situation. These are commonly referred to as the ‘5 C’s’:

1. Character. What kind of borrower will you be for the bank? Character is the general impression you make on the potential lender. It is a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan. Companies don’t repay loans, people do. Your educational background, experience in business and in your industry, the quality of your references, and the background and experience of your management team will all be considered in making this assessment.

2. Credit history. Qualifying for different types of credit hinges largely on your credit history. Many lenders use credit scores to help them in their lending decisions, and each lender has its own criteria, depending on the level of risk it finds acceptable for a given credit product.

3. Capacity. This is the monthly or annual revenues question. No lender is interested in providing a loan to someone who has no means to repay it. Lenders will consider cash flow available to service debt (EBITDA) and the company’s debt service coverage ratio.

4. Collateral. Lenders may make both secured and unsecured loans. Lenders may require you to pledge assets like real estate or capital equipment as collateral. Alternative lenders might consider your accounts receivable, inventory or monthly credit card receipts as collateral.

5. Capital. Capital is the money you personally have invested in the business and is an indication of how much you have at risk should the business fail. To your lender, capital represents your ‘skin in the game.’ Remember that bankers are highly risk-averse and want to ensure borrowers have some skin in the game. From their perspective, borrower’s capital will make it harder to walk away.

How have regulations impacted banks and their willingness to lend?

Historically, commercial lenders were not burdened by the same degree of regulations as consumer and mortgage lenders. It was not uncommon that a few notes on a napkin, or a handshake over drinks, were all that a lender needed to initiate a commercial loan request.

That changed with the enactment of the Dodd-Frank Act which has had a significant impact on the manner in which banks conduct business. Dodd-Frank increased the compliance stakes in the commercial application process through new data collection requirements.

Consequently, the timeline from initiation of a loan request to settlement has expanded. New regulations make it more advantageous for a borrower who may need to restructure a loan to find another bank rather than to stay with the current lender.

A loan restructured with an extended amortization with a current lender may be considered a troubled loan, whereas with a new lender it may not be.

Are there intangible factors that a business owner should consider?
Similar looking banks may have a different appetite for providing loans to certain industries. One lender may be interested in technology companies, while another may avoid them.

Additionally, depending upon the size of the bank, the bank may be near its lending capacity for a certain industry.

Business owners should speak with their financial advisers who can assist in matching the company with the right lender. It’s all about relationships, and working together to achieve a common goal. ●

Insights Accounting & Consulting is brought to you by Kreischer Miller

How sustainable companies focus on the long term to build success

In light of the sheer volume of short-term challenges businesses face, it can be easy to forget to focus on activities that lead to long-term success.

“Companies generally don’t demonstrate success over decades by accident,” says Christopher Meshginpoosh, Director, at Kreischer Miller.

“When you analyze the traits of those that are successful over the long-term — that is, those with sustainable businesses — many common themes emerge.”

Smart Business spoke with Meshginpoosh about the common traits of sustainable businesses.

What do executives at sustainable businesses do differently than others?

One of the obvious things is that they do a better job of focusing on long-term objectives. This is an area where family businesses often outperform others. Because of their sense of obligation to the family, owners tend to make decisions based on the potential impact on future generations rather than on near-term results.

Are sustainable businesses often more frugal than others?

There are times when all businesses tend to be more frugal, such as during economic downturns. However, one factor that contributes to long-term success is managing costs with the same degree of urgency in both good and bad times. This is another area where family businesses tend to do a much better job. They often avoid committing to unnecessary fixed costs during good times, which reduces the risk of losses during economic contractions.

Another benefit of lower fixed cost levels is that it reduces the need for layoffs during a downturn, which can foster employee loyalty and reduce long-term turnover rates.

How do sustainable companies measure their performance?

They tend to focus on traditional profitability and leverage metrics even when others no longer think they are important. Remember the dot com bubble? There were plenty of companies, investors and analysts that said profitability and cash flow did not matter.

While it’s possible to trade profits for revenue growth while capital and credit markets are open, it can be a recipe for disaster when the economy tightens. Closely-held businesses often thrive in this regard because the higher cost of capital requires that they monitor profitability, cash flow and leverage.

Are there aspects of long-term success where public companies have the upper hand?

Public company boards often do a much better job focusing on management succession plans. Additionally, incentives offered by public companies — like stock options or stock awards — can help them lure top talent. However, private companies also have a variety of financial incentives at their disposal, such as phantom stock programs or deferred compensation programs.

How do sustainable companies keep employees engaged?

They don’t rely solely on economic incentives. Many studies have shown that employee satisfaction is highly correlated with the level of control or autonomy granted to employees. This is where family businesses often struggle, because granting an outsider a seat at the table can be difficult.

However, unless there is an unlimited bench of talented family members, a family-owned business may not be successful in the long-run without granting some form of managerial control to outsiders.

What approach do these businesses take toward mergers and acquisitions?

These companies tend not to bet-the-farm on risky acquisitions, such as those involving large targets or those that require a substantial amount of debt financing. Avoid those two, and your odds of thriving in the long-term will dramatically increase even if a particular acquisition doesn’t turn out as planned.

While there will always be risk in business, adopting some of these techniques can reduce risk and increase the odds that your business will outlast you.

Insights Accounting & Consulting is brought to you by Kreischer Miller

 

The changing face of state tax nexus may unsettle many businesses

Nexus, the degree of contact between a business and a state that allows a state to impose taxes, has always been a difficult concept to define. Defining nexus has never been a “one size fits all” concept when it comes to state taxation, but with most states allocating more resources to identifying non-filers, the risk of detection has become greater than ever.

“Businesses need to be aware of their activities in multiple states to assess whether they have a filling responsibility in those states,” says Thomas M. Frascella, Director, Tax Strategies, Kreischer Miller.

Smart Business spoke with Frascella about the evolving nexus landscape.

What is important for businesses to know about the latest taxation trends?

In today’s aggressive state taxing environment, it is essential that businesses understand the types of taxes that states impose and the degree of contact with a state that could trigger a responsibility to comply with state rules. Sales tax, for example, historically required that a business have “substantial or physical presence” in a state before it was required to collect and remit sales tax. Today, states are revisiting the traditional notion that physical presence is a necessary element to sales tax nexus by promulgating rules and regulations that adopt a nexus standard based on a business’ affiliation with another business.

Does this have significant implications for business organizations?

The affiliated nexus standard is aimed at remote sellers who may not have any other connection with a state other than through financial relationships with businesses that facilitate sales with its customers. Businesses using these affiliate relationships could find that they have nexus in more than just the states where they have a physical presence. The issue of affiliated nexus has become so heated that the federal government has attempted to regulate the taxation of out-of-state sellers by introducing legislation to essentially protect “main street” businesses from complying with such rules.

What has been the reaction of the states to stimulate the tax flow?

States have also responded to the severe fiscal crisis they have been operating under by rushing to enact taxes that require a lesser presence and seek to establish more of a “bright line” nexus standard. For example, Ohio enacted the Commercial Activity Tax (“CAT”) which adopted a factor presence standard for imposing nexus on out of state businesses. The State of Ohio argued that because the tax was neither a sales tax nor an income tax, physical presence was not necessary to create nexus with the state.

The factor presence nexus standard claims to establish substantial nexus when certain thresholds around property, payroll or sales are met. The Ohio CAT statute requires that an out-of-state business have either $50,000 of payroll in Ohio, $50,000 of property in Ohio, $500,000 of gross receipts in Ohio or at least 25 percent of the business’ total property, payroll or gross receipts in Ohio.

Is factor presence here to stay?

The popularity of the factor presence test is beginning to grow and more states are beginning to see it as a means of expanding the current taxpayer base without resorting to the unpopular measures of raising tax rates or implementing new taxes. Factor presence has even crept into the area of state income taxes. It has begun to replace the historical physical presence test which has been the linchpin of state income tax nexus for decades. California was the first state to adopt factor presence as it related to the Franchise Tax, a tax that is imposed on the net income of a business.

Other states have followed suit, including Colorado, Connecticut and Michigan. It is too early to tell whether the use of factor presence test will survive legal challenges that are sure to be raised. However, businesses that have customers located in states where they do not currently have a physical presence should review their current operations to assess if exposure to other state taxes, such as sales, gross receipts and even income taxes exists under these new nexus standards.

Insights Accounting & Consulting is brought to you by Kreischer Miller

Key factors can make the difference between stagnation and success

Far too often, companies hope for an “aha” moment — viewing innovation as a sort of magical event that occurs out of thin air. However, in reality, innovation is often the result of a long, costly and painstaking process.

Additionally, if a company relegates innovation to its research and development department and wonders why R&D is not having the success hoped for, that company is not alone. This is a common mistake, and it can be made worse if R&D has little direct interaction with customers or prospects.

Smart Business spoke with Christopher Meshginpoosh, Director of Audit & Accounting at Kreischer Miller, on creating a company culture of innovation.

What can a company do if it has committed time and energy, but has not seen results?
When companies stagnate, it is often the result of tunnel vision. Sometimes it can be difficult to approach a common problem from a new perspective. One way to combat this is to engage team members from unrelated functions or lines of business. By doing this, the teams will not be as heavily influenced by current habits and are more likely to achieve breakthroughs.

If a company does not have multiple lines of businesses or functions from which to draw, it should consider bringing in an outsider, and not shy away from one who knows nothing about the industry.
Engaging someone who is unencumbered by longstanding assumptions can lead to game-changing insights.

How can companies engage other employees in the process?
For those who really want to create a culture that fosters innovation, innovation cannot be a part-time job.
Innovation takes time and energy. If employees are always up to their eyeballs with other responsibilities, a company will most likely fail. To be successful, an organization needs to provide time and space for employees to focus on products, services or processes. This may mean allowing key employees to spend as much as 10 to 15 percent of their time trying to come up with the next big idea.

Are there other ways to overcome stagnation?
Many times, innovation simply comes from observing something in a seemingly unrelated field and connecting or associating that observation with the problem a company is trying to solve. As a result, sometimes the best way to solve a problem is simply to leave.

Taking a vacation or getting away not only recharges team members, but also provides them with the chance to see things — products, services, or processes in other industries or geographies that could result in breakthroughs in the industry. Additionally, leaving the confines of the office to get out and observe customers in action can help personnel challenge assumptions and generate new ideas.

What other approaches stifle innovation?
Those companies struggling with a lack of quantity or quality of new ideas, should consider how the organization reacts to failure. If failure typically results in negative outcomes — poor performance evaluations, lower raises, embarrassment or dismissal — culture may be the problem.

To create an environment where employees feel safe sticking their necks out, a company should celebrate the effort and accept the fact that for every 10 ideas that fail, one idea may be the groundbreaking idea that was sought.

Are young people better at innovation?
The press tends to celebrate youthful innovators, so it’s assumed the best innovators are young. However, if that were the case, why is the average age of a Nobel Prize Laureate well over 50?

While industries such as technology tend to have many more young disruptors, the skills necessary for innovation in many other areas come from years of experience and observation. So if a company’s goal is to create breakthroughs, make sure it includes some people with gray — or no — hair.

Insights Accounting & Consulting is brought to you by Kreischer Miller

 

How to manage the risks to seize the opportunities to go international

The reasons for a business to consider expanding internationally are many and compelling: the domestic market for its products or services is saturated, intense competition, margin pressures, etc. The goal is to increase revenues and expand market share.

There is also sourcing as a motive — looking for ways to reduce costs or risks in the supply chain — and production — looking for lower labor costs and being physically closer to new or emerging markets.

“Such a decision can be daunting and should not be made without careful consideration of the risks; after all, for most companies, global markets represent a great unknown,” says Michael A. Coakley, Director, Audit & Accounting, Kreischer Miller.

Smart Business spoke with Coakley on what businesses should know when they consider global expansion.

What is the biggest challenge when expanding internationally?

Perhaps the most significant risk or challenge of expanding internationally is navigating the culture gap. Every country has its own language and culture, and successfully working with them requires some knowledge of how the country prefers to transact business, along with the ability to effectively communicate. This is oftentimes accomplished by having someone ‘on the ground’ in that country — whether an employee or a representative — who is a native or is otherwise knowledgeable of the culture.

Another risk is the longer sales cycle inherent in these transactions due to distance and shipping obstacles. Whether you are selling to or sourcing from abroad, longer lead times must be factored into the cycle, as products could spend a considerable amount of time ‘on the water’ or tied up in customs. Unanticipated delays could lead to stock-outs or delays in the manufacturing cycle, or missed delivery dates to customers, leading to dissatisfied customers and possibly future lost sales.

This also ties into another risk, tarnishing your brand. A reputation for being late would almost certainly cause damage to your brand both domestically and abroad.

Are there any other risks a company should consider?

Other possible risks to a company’s brand and image relate to quality and quality control — whether perceived or real. And then there are social and ethical dilemmas companies may face in other parts of the world — poor working conditions and lack of regard for safety and environmental hazards. Your company’s relationship to or involvement in these situations could prove disastrous.

There are also the hidden or unexpected costs of doing business abroad, such as customs duties, taxes/tariffs, letter of credit fees and insurance. And there is the almost certain significant travel costs associated with a company’s sales or operational leaders needing to spend considerable time in the foreign land to monitor the activities of those working on their behalf; making sure that the local cultural customs are being adhered to, and at the same time, the values of the company as well.

No less important to the decision to expand internationally are the foreign countries’ economic and sociopolitical climates, and foreign currencies and exchange rates. With so much instability and changing demographics affecting many parts of the world, these have to be closely monitored — both at the outset of global expansion and on an ongoing basis.

How does a business handle the risks?

Most if not all of these risks can be mitigated with proper planning and due diligence. Formulation of a strategic plan for international growth and consultation with your trusted business advisors — accountants, attorneys, bankers — are key.

In addition, assistance, including some direct government funding and government-funded services, may be available and can be accessed through a World Trade Center affiliate (locally, the World Trade Center of Greater Philadelphia). The federal and state governments allocate resources to assist companies going global, but these resources are often underutilized as companies don’t realize they exist.

Insights Accounting & Consulting is brought to you by Kreischer Miller.

Creative deferred compensation packages can attract and retain valuable key employees

In today’s talent marketplace, deferred compensation is one tool to be considered if a company wants to attract — and retain — key people.

“Many closely-held businesses may not or cannot offer equity compensation in the form of stock, but they still have to be able to hire and retain good people, and a deferred compensation package is clearly something to think about,” says Lawrence Silver, Director, Tax Strategies, with Kreischer Miller.

Smart Business spoke with Silver about the types of deferred compensation and how they can be used, as well as any risks that may be involved.

What are some types of deferred compensation? A deferred compensation plan may involve an employee who earns a comfortable salary but may not currently need all of it. Abiding by the proper format, the employee can elect to have the company hold a percentage of his or her current compensation and defer the payment to some future specified date. In the interim, the deferred compensation is being invested by the employer.

Another use of a deferred compensation plan is when a company takes its own money and puts some away on behalf of a key employee, perhaps for short-term or long-term incentives, to keep and maintain that employee so the employee has certain goals to reach. Again, the employee may only have access to those funds upon meeting some very specific criteria.

How does deferred compensation differ from a 401(k) plan? A 401(k) plan is a qualified plan and is available for most employees wherein an employee can defer some of his or her current compensation. Deferred compensation is an unqualified plan and is usually in addition to a 401(k) plan to provide benefits to key employees or higher paid employees who want to be able to defer more compensation than is allowed under a 401(k) plan. Deferred compensation is a tool to go beyond the basic 401(k) plan to offer more benefits to key employees.

Are there any risks in a deferred compensation plan? There are significant risks. The risk for the employee is that deferred compensation is really a promise by the company to pay. It may be a legally binding obligation under the arrangement the employee has with the employer, but at the same time, the employee is nothing more than a general creditor of the employer. So if the employer goes bankrupt or faces hard times, it may be impossible for the employee to ultimately obtain his or her deferred compensation.

The employer must recognize the potential payment of the deferred compensation as an unfunded liability on its financial statements. This liability could affect borrowing capacity and financial covenants because it is a legal obligation.

Additionally, the employer may only claim a tax deduction at the time of payment.

What type of companies or corporations use deferred compensation plans? While all types of companies use deferred compensation plans, it is not limited to public companies or large private companies.

A private company, where perhaps the company is family owned and doesn’t want to offer equity to nonfamily members, may use a deferred compensation plan known as a “phantom stock” plan. Such a plan mimics the increase in value of the company’s equity over the years. That employee can then participate in the incremental value of the stock while not being an actual stockholder. The downside here is that the ultimate payment under this plan is taxed to the employee at ordinary income tax rates as opposed to lower capital gains tax rates.

What are some mistakes employers make and how can they be avoided? There are specific rules under the Internal Revenue Code and its regulations that must be strictly followed. There can be significant penalties for the employee if deferred compensation is received prematurely. These plans must be reviewed by legal counsel and financial advisers because it’s possible to inadvertently create a situation that was unintended.

WEBSITE: For information about deferred compensation plans, visit www.kmco.com.

Insights Accounting & Consulting is brought to you by Kreischer Miller 

How boards of directors can offer insight and help a business succeed 

A formal board of directors is a basic tenet of a company’s governing documents. Most people understand the significance of such a body within the public company world. Unfortunately, far too many private companies recognize only the legal formality of a board; too few understand the incredible value such a group can provide.

“Often, the most successful private companies utilize an advisory board or board of directors to hold owners accountable for goals and provide insight into a variety of matters”, says Stephen W. Christian, Managing Director of Kreischer Miller.

Board members can serve as experienced mentors who complement the knowledge and skills of management.

Smart Business spoke with Christian regarding common issues with which a board can assist and how to choose the right candidates.

How can a company benefit from utilizing a board of directors? Most significantly, an effective board can provide accountability mechanisms for management and outside perspectives that help business owners make grounded, forward-thinking decisions. The talents of a board supplement the skill sets of management. In addition, an organization’s credibility is often enhanced by its board of directors.

What kind of issues do boards help with? In general, a board should weigh in on matters impacting the long-term advancement and protection of an organization. Business owners focus on the time-sensitive demands of the day, regardless of importance, while deferring critical long-term or complex issues. Boards often deal with topics such as strategic direction, risk management, growth strategies, succession and financing.

What should you look for in a board member? First, define your needs and expectations. What skills, expertise, contacts and other factors are important? Directors should be candid, provide constructive feedback and hold people accountable. Individuals who previously owned and operated businesses often have valuable entrepreneurial experience and strategic thinking capabilities. A board member may or may not have relevant industry experience — both perspectives provide value.

Sometimes the need for functional expertise and an objective perspective trumps the need to engage someone with similar industry experience. It is very important to look for a person with a sincere interest in the process who will work diligently to fulfill the responsibilities.

What’s the best process to identify good candidates for a board of directors? Talk to your professional advisers, review annual reports for local public companies, contact applicable industry associations, engage an executive recruiter, contact the National Association of Corporate Directors and talk to other business owners you know. Be specific regarding the qualities desired. Once identified, contact candidates personally. They will want to hear your vision, passion and desires and will determine for themselves whether the opportunity is a good fit for them. Try to stay away from friends and relatives; often it is difficult for them to provide the required objectivity and candidness.

How do business owners keep board members engaged and functioning at peak levels? Significant effort goes into an effectively functioning board, from both the owner’s and board members’ perspectives. If done correctly, the value resulting from the process will far outweigh the costs. A business owner must be committed to the initiative — not just go through the motions of having meetings.

Best practices for effective boards include scheduling regular meetings, with sensitivity to the board members’ time demands; preparing for meetings and creating meaningful agendas; distributing information in advance so that members have time to read and digest it; and having the courage to replace non-performing board members. It is also critically important for an owner to keep an open mind. ● 

Insights Accounting & Consulting is brought to you by Kreischer Miller 

S corporation vs. LLC: Which is the better option?

One of the first tasks a new business owner must address involves the question — What type of entity should I choose to operate my business?

“A common tax consideration is a desire to avoid double tax in which the operating profit of a business is taxed initially at the entity level, followed by an additional tax when after-tax profit is distributed to the owners,” says Michael R. Viens, Director, Tax Strategies, Kreischer Miller.

Smart Business spoke with Viens about considerations that may arise should you decide to operate a business venture as a pass-through entity, either a limited liability company (LLC) or an S corporation.

Does incorporation help protect personal assets from a business?

When a company decides to operate a business using a formal intermediary entity, it’s typically to shield the business owners’ personal assets from the risks of the business’s creditors. Both LLCs and S corporations offer this benefit. But there are formalities that must be addressed to assure such results.

Some advisers argue that the formalities and related paperwork are more of a burden for an S corporation. For example, there are annual meetings and corporate minutes requirements. An LLC avoids such requirements. Such activities need not be a material burden, however, and offsetting this issue is the greater clarity an S corporation offers with its formal ownership structure.

S corporations do have greater restrictions on ownership than LLCs. Permitted S corporation shareholders are both limited in number (no more than 100) and type (generally, U.S. citizens or permanent residents and certain trusts).

What are the tax implications between the two types of entities?

An owner in an LLC is treated as a partner in a partnership for tax purposes and partners do not qualify as common-law employees with regard to the partnership. LLC owners cannot receive W-2 wages in which tax is withheld, and thus owners are required to make quarterly estimated tax filings, a consideration that could weigh against using an LLC.

Wages paid to an S corporation owner for services performed are subject to Social Security and Medicare taxes but allocations of S corporation profits will not be.
Allocations of LLC profits to a member who performs services in the LLC generally will be subject to Social Security and Medicare taxes. For a service-oriented business venture, this can favor an S corporation. It is important to note, however, that tax reform provisions now being considered would potentially eliminate the favorable benefit currently realized by S corporation shareholders.

Where the activities of the business venture do not involve personal services but rather some form of investment activity, passive income limitations may prevent the use of an S corporation. Using an LLC for ownership of real estate involved in rental activities is usually preferred.

If a business venture will own property likely to appreciate in value and a reasonable prospect exists that new owners will acquire a future interest, an LLC provides for favorable tax considerations to such owners. They may acquire a stepped-up basis to be used to determine both deductions flowing to them as well as their share of any gain or loss upon disposition of such assets by the LLC. No such basis step-up is allowed to S corporation shareholders.

Where losses may be anticipated from business operations, an LLC may provide a better outcome to the owners since loss limitations referencing owners’ basis will typically include mortgage and other debt inside the entity. S corporation shareholders are limited to their stock basis and any personal loans they have made to the entity.

Which type is better?

It is not uncommon for there to be some level of uncertainty about which form represents the best solution when a new business venture is launched. In such circumstances, consider going with an LLC approach at least initially while reserving the option to change to an S corporation in the future. Such a change can generally be carried out with little or no immediate tax implications, while a move in the opposite direction can present significant tax costs.

Insights Accounting & Consulting is brought to you by Kreischer Miller

How to achieve a lean finance department in your company

As successful companies grow over time, certain systems — particularly within the finance function — are often overlooked. As a result, multiple software applications are typically pieced together in order to extract and maintain data. Processes become redundant in order to get information into these various systems and precious time is wasted along the way.

Running a lean finance department requires stepping back and taking a fresh look every once in awhile.

“I often see software accounting packages being used to track the basic activities of the business,” says Steven E. Staugaitis, CPA, Director, Audit & Accounting at Kreischer Miller. “These packages are often accompanied by an excessive amount of spreadsheets to track various aspects of the business — from budgets and sales data to creating the monthly internal financial statements.”

Smart Business spoke with Staugaitis on the advantages of operating a lean finance department and how to accomplish it.

What do you look for in a lean finance department?

I want to observe six key elements: 1) The accuracy of the information being generated, 2) the timeliness of the information being prepared, 3) the effectiveness of the internal controls, 4) the overall quality of the reports themselves, 5) the efficiency of the technology that’s being used and 6) the overall sufficiency of the personnel within the department.

Can you provide some more detail?

The accuracy of the information has to do with the completeness of the information or, said another way, the number of adjustments that are being posted in any given period.

Timeliness involves the speed at which the department generates a set of internal financial statements. Well-run organizations will be able to close their books at the end of each month within five business days. But anywhere under two weeks is a pretty healthy indicator.

The internal control structure has a lot to do with how personnel are allocated within a department. In a smaller organization, some level of owner oversight or involvement is a good way to mitigate risk.

The quality of the reports really has to do with the type of information being provided on a monthly basis. Look for key performance indicators or other types of dashboard reporting in addition to a simple balance sheet and income statement.

The efficiency of the technology involves how well the business is using its systems and if it is making sufficient use of them.

The personnel aspect has to do with not only staffing levels, but also the overall quality of your people.

Where would you begin to improve this?

I usually suggest starting with the end users or the information recipients and understand what they need. It’s senseless to create reports no one ever uses just because that’s the way it has always been done.

Secondly, take a hard look at your existing technology to see if there are features or software modules that are not being used or are being used improperly. There may be some real opportunities to improve functionality without having to make major investments in a new system.

Lastly, take a close look at your personnel. Evaluate whether you have enough resources or need to make some changes.

What are some of the obvious places to find waste?

The area I tend to see the most waste in is often redundancy or duplication of efforts. So many businesses don’t really make effective use of their technology; specifically, I often see excessive use of spreadsheets in addition to accounting software to manage the finance side of the business.

At what point would you consider a finance department to be running lean?

I think you simply see it in the results of the business. Well-run departments are able to improve turnaround time of financial information and drive improvements throughout other aspects of the business. The only way to track improvements is to make them definable and measurable. Then you can compare your performance to yourself, your peers or other well-run companies. So where do you stand?

Insights Accounting & Consulting is brought to you by Kreischer Miller.