Instead of only printing the QuickBooks® reports as is, take time to review the specific order and organization in which these Financial Statements need to appear, so that the bank can perform a quick and accurate analysis of the financial health of the business.

The Income Statement (or Profit & Loss in QuickBooks) is recommended to be organized as follows:

Cogs Used to Calculate Gross Profit

  • Direct
  • Typically Variable
  • Associate with Customer or Job
  • Predicable, based on sales

Expenses Used to Calculate Net Profit

  • Direct
  • Typically Variable
  • Associate with Customer or Job
  • Predicable, based on sales

Other Income and Expenses

Interest Income, Interest Expenses, Depreciation, Amortization, Income Tax, Capital Gains/Losses, Extraordinary Items

Predicable, based on sales

A key area of focus is correctly identifying Cost of Goods Sold (COGS) vs. Operating Expenses (Expenses), to ensure that there is proper assessment of GROSS PROFIT and GROSS MARGIN. Gross Margin percentage will portray a lot about a business. For example, if you have LOW gross margin percentages, such as 7%, you can imply (even without knowing anything about the business itself) that they are usually focused on volume sales, low priced and lower quality items, and mostly products, (Example: ExxonMobil). However, if the business has high profit margins, reaching over 40%, you can suggest that the business has a mixture of services with products, and is concentrates on a higher priced, higher quality product, such as Apple.

The NET PROFIT shows that the business will have the ability to repay the loan, which in the end, that’s what they are interested.

Extraordinary and Non-Operating items should also be property identified; specially, if you had a particular year with a large loss that is not expected to be recurrent, the bank may consider excluding that from the NET PROFIT calculation.

The Balance Sheet should be organized as follows:

Current Assets:

Cash or Convertible to Cash within an operating Cycle

  • Bank
  • Financial Investments
  • Accounts Receivable
  • Inventory
  • Short Term Loan Receivables

Fixed Assets:

Required infrastructure to produce income

  • Useful Life > 1 Year
  • Gets Depreciated
  • Min. Threshold, typically > $500

Other Assets:

Franchise Fee, Goodwill, Security Deposits, Capitalized/ Amortizable Investments, Long Term Loan Receivables

The Liquidity of the Business is what banks are mostly focused on, meaning the higher the amount of Current (or highly liquid) Assets, the better chance the bank has to recover their funds if the loan goes bad. Fixed assets occasionally serve as Collateral, where a particular equipment or real estate asset backs some loans. That’s illustrated below:

Current Liability

Claims against your assets, payable within an operating cycle

  • Credit Card
  • Lines of Credit
  • Loans payable within 1 year

Long Term

  • Payable after 1 year

Equity – Net Worth

Roll Retained Earings to Capital Accounts for each owner (S-Corps & Partnerships) Aditional paid in Capital better than shareholder loan

A lot of banks want to lend to businesses that are already with high debt because it could become difficult to pay back all those loans. The banks are very aware that a business may file bankruptcy, and typically, the owners don’t give any liability to pay them back. So, this could be a red flag. The other possible concern is that if there are other banks that have lent the business before, they may have a BLANKET LIEN on the business, meaning the new lender is in second position for collateral, resulting in a much lower probability of collecting that loan if it goes sour. Moreover, there is typically a domino effect; if one loan defaults, all default.

Equity, the NET WORTH of the business, is also very important. Equity is increased with Net Income (Retained Earnings) and Owner’s Capital. In other words, if the business owner(s) keep the profit inside the business, equity maintains and grows. However, if they distribute all the profits, equity stays stagnant or decreases.

Lastly, there is “Credit Philosophy.” Most banks create basic approaches for lending that make it easy to understand the guidelines or philosophies for assessing risk before releasing any credit. A good illustration of that is the “Five C’s of Credit,” shown below:

  1. Capacity: can the borrower repay the loan?
  2. Capital: is the borrower invested into the business. Are they putting in a down payment?
  3. Collateral: if the loans default, can the bank recover the capital with the collateral?
  4. Conditions: Is the industry in good form? Are there regulatory or external factors affecting the borrower?
  5. Character: credit history and statistical risk.

The concept behind understanding these ideas is the ability to PREPARE for the bank loan application process. This is very similar to disclosure notes that are often prepared by a CPA during Audits. Other than hiring a CPA to prepare these financial statements for the bank, the other most crucial thing a small business owner can do is set up a “Narrative” structured like a Business Memo or Business Plan that create a solid illustration for why this business requires a loan, what the funds will be used for, how this cash flow addition grows sales and the bottom line, and lastly, a great explanation on how the constant operation affects all items on the financial statements.

RS targeting small firm retirement plans.

Whether you are employed or a freelancer, ensure your firm’s plan is up to date, whether you are a freelancer or employed. An increase in IRS audits of retirement plans will direct attention on types of plans and issues that experience has shown are likely to result in non-compliance.

The targets:

SIMPLE plans. The 100-employee limitation is the largest issue for SIMPLE plans. Firms that can have a SIMPLE plan are those who have no more than 100 employees with $5,000 or more in compensation during the previous year.

SEP plans that consist of salary decrease. To be considered eligible for SEPs, employers should verify that the plan was timely implemented and that all employees who are at least 21 years of age and have carried out services in three of the five previous years.

Avoid criminal charges booking “loans.” When a small business categorizes payments to the owner or for the owner’s advantage as loans instead of salaries, dividends or bonuses, the government is opt to turn a tax audit into a criminal investigation. The government is likely to investigate the tax preparer or bookkeeper who neglected to perform due diligence or otherwise assisted the business owner in the fraud, even if the assistance was passive, according to a U.S. Justice Department official speaking at a recent conference. Even if the individual isn’t charged with a crime, they are likely to have to undergo an investigation of their activities. Bookkeepers and tax preparers should make sure that transactions catalogued as loans are real and documented. “Real” is proven by documentation of the loan, accrual of interest charged and of payments of interest and principal. The terms of the loan agreement must be complied with. You can’t monitor the activities of those you work for, however, you can ask for clarification and document your conversation. Business owner agree to a plea deal with the government so the prosecutor’s main target becomes the tax preparer or bookkeeper. The responsibility will be on the tax preparer.

How to self-correct: Use the IRS Employee Plans Compliance Resolution System (EPCRS). The IRS expanded the self-correction options available in Rev. Proc. 2019-19, 2019-19 IRB 1086. This doesn’t increase the chance of an employer being audited.

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