Cash Flow

Posted by PITHOCRATES - March 24th, 2014

Economics 101

New Complex and Confusing Regulatory Policies require Additional Accounting and Legal Fees to Comply

There have been demonstrations  to raise the minimum wage.  President Obama even called for Congress to raise the federal minimum wage to $10.10 an hour.  He also wants employers to pay salaried people overtime.  There have been demands for paid family leave (paying people for not working).  Unions want to organize businesses.  To get employers to pay union wages.  Provide union health care packages.  And union pensions.  Obamacare has made costly health insurance mandatory for all employees working 30 hours or more a week.

Environmental regulations have increased energy costs for businesses.  Sexual harassment training, safety training, on-the-job training (even people leaving college have to be trained before they are useful to many employers), etc., raise costs for businesses.  New financial reporting requirements require additional accounting fees to sort through.  New complex and confusing regulatory policies require additional legal fees to sort through them and comply.

With each payroll an employer has to pay state unemployment tax.  Federal unemployment tax.  Social Security tax (half of it withheld from each employee’s paycheck and half out of their pocket).  Medicare tax.  And workers’ compensation insurance.  Then there’s health insurance.  Vehicle insurance.  Sales tax.  Use tax.  Real property tax.  Personal property tax.  Licenses.  Fees.  Dues.  Office supplies.  Utilities.  Postage.  High speed Internet.  Tech support to thwart Internet attacks.  Coffee.  Snow removal.  Landscaping.  Etc.  And, of course, the labor, material, equipment and direct expenses used to produce sales.

The Problem with Guaranteed Work Hours is that there is no such thing as Guaranteed Sales

The worst economic recovery since that following the Great Depression has created a dearth of full-time jobs.  In large part due to Obamacare.  As some employers struggling in the worst economic recovery since that following the Great Depression can’t afford to offer their full-time employees health insurance.  So they’re not hiring full-time employees.  And are pushing full-time employees to part-time.  Because they can’t afford to add anymore overhead costs.  Which is hurting a lot of people who are having their own problems trying to make ends meet in the worst economic recovery since that following the Great Depression.  Especially part-time workers.

Now there is a new push by those on the left to make employers give a 21-day notice for work schedules for part time and ‘on call’ workers.  And to guarantee them at least 20 hours a week.  Things that are just impossible to do in many small retail businesses.  As anyone who has ever worked in a small retail business can attest to.  You can schedule people to week 3 weeks in advance but what do you do when they don’t show up for work?  Which happens.  A lot.  Especially when the weather is nice.  Or on a Saturday or Sunday morning.  As some people party so much on Friday and Saturday night that they are just too hung over to go to work.  Normally you call someone else to take their shift.  Then reschedule the rest of the week.  So you don’t give too many hours to the person who filled in.  In part to keep them under 30 hours to avoid the Obamacare penalty.  But also because the other workers will get mad if that person gets more hours than they did.

The problem with guaranteed work hours is that there is no such thing as guaranteed sales.  If you schedule 5 workers 3 weeks in advance and a blizzard paralyzes the city you may not have 5 workers worth of sales.  Because people are staying home.  And if no one is coming through your doors you’re not going to want to pay 5 people to stand around and do nothing.  For with no sales where is the money going to come from to pay these workers?  Either out of the business owner’s personal bank account.  Or they will have to borrow money.  It is easy to say we should guarantee workers a minimum number of work hours.  But should a business owner have to lose money so they can?  For contrary to popular belief, business owners are not all billionaires with money to burn.  Instead, they are people losing sleep over something called cash flow.

Cash Flow is everything to a Small Business Owner because it takes Cash to pay all of their Bills

To understand cash flow imagine a large bucket full of holes.  You pour water in it and it leaks right out.  That water leaking out is expenses.  The cost of doing business (see all of those costs above).  A business owner has to keep that bucket from running out of water.  And there is only one way to do it.  By pouring new water into the bucket to replace the water leaking out.  That new water is sales revenue.  What customers pay them for their products and/or services.  For a business to remain in business they must keep water in that bucket.  For if it runs out of water they can’t pay all of their expenses.  They’ll become insolvent.  And may have no choice but to file bankruptcy.  At which point they’ll have to get a job working for someone else.

Cash flow is everything to a small business owner.  Because it takes cash to pay all of their bills.  Payroll, insurance, taxes, etc.  None of which they can NOT pay.  For if they do NOT pay these bills their employees will quit.  Their insurers will cancel their policies.  And the taxman will pay them a visit.  Which will be very, very unpleasant.  So small business owners have to make sure that at least the same amount of water is going into the bucket that is draining out of the bucket to pay their bills.  And they have to make sure more water is entering the bucket than is draining out of the bucket to pay themselves.  And to grow their business.

This is why business owners don’t want to hire full-time people now.  Because full-time people require a lot of cash (wages/salary, payroll taxes, insurances, training, etc.).  They’re nervous.  For they don’t know what next will come out of the Obama administration that will require additional cash.  For every time they want to make life better for the workers (a higher minimum wage, overtime for salaried employees, guaranteed hours, etc.) it takes more cash.  Which comes from sales.  And if sales are down future cash flow into the business will also be down.  Leaving less available for all of those holes in the bucket.  So they guard their cash closely.  And are very wary of incurring any new cash obligations.  Lest they run out of cash.  And have to file bankruptcy.  Which is why they lose sleep over cash flow.  Especially now during the worst economic recovery since that following the Great Depression.


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Trend Analysis—Long-Term Debt-Paying Ability

Posted by PITHOCRATES - January 28th, 2013

Economics 101

To Help with the Decision Making Process Small Business Owners look at Past Results and Trends

A small business owner has a lot on his or her mind.  Most of which have something to do with cash.  If they will have enough for their short-term needs.  And their long-term needs.  Because if they don’t there’s a good chance he or she will be a small business owner no more.  So with every decision a small business owner makes he or she asks this question.  What will be the cash-impact of this decision?  Both short-term.  And long-term.

To help with this decision making process small business owners look at past results.  And the trend between accounting periods.  Either quarterly.  Or monthly.  For there is a lot more to a business’ health than net profit.  Or cash in the bank.  You can have neither and still be a healthy business.  And you can have both and be in a lot of danger.  Because these are only parts of the bigger picture.  It’s how they fit together with the other pieces that give small business owners useful information.  So let’s take a look at 4 quarters of fictitious data.  And what the data trends tell us.

Trend Analysis Long-Term Debt

Looking at these numbers you can arrive at different conclusions.  Sales were 1.7 million or higher for all 4 quarters.  That seems good.  But sales fell the last two quarters.  That seems bad.  But it’s hard to get a full grasp of what these numbers can tell us on their own.  But if we look at some ratios we can glean a lot more information.  And can graph these ratios and look at trends.

If the Debt Ratio is less than 1 it means the Business is Insolvent

If you divide current assets (Cash through Inventory) by current liabilities (Accounts Payable through Current Portion of L/T Debt) you get the current ratio.  A liquidity ratio.  Telling a small business owner his or her short-term (in the next 12 months) cash health.  If this ratio is greater than one than you have more current assets than current liabilities.  Meaning you should be able to meet your cash needs in the next 12 months.  Which is good.  If it’s less than 1 it means you may not be able to meet your cash needs in the next 12 months.  Which is bad.  But is there a ‘correct’ number for a small business?  No.  It could vary greatly depending on the nature of your business.  But the trend of the current ratio can provide valuable information.

Trend Analysis Long-Term Debt Current Ratio

This business became more liquid from Q1 to Q2.  Meaning they should have been able to meet their short-term cash needs even easier in Q2 than Q1.  A good thing.  But they became less liquid from Q2 to Q3.  With their current ratio falling below 1.  Meaning they may not have had enough cash to meet their short-term cash needs.  Their short-term cash position improved in Q4.  But it was still below one.  So the current ratio trend for these 4 quarters shows a cause for concern.  Is it a problem?  It depends on the big picture.  So let’s look at more parts that make up the big picture.

Plotted on the same graph is a long-term debt-paying ability ratio.  The debt ratio.  Which we get by dividing Total Assets by Total Liabilities.  If this number is less than 1 it means Total Assets are greater than Total Liabilities.  Which is good.  If it’s greater than 1 it means the business is insolvent.  Which is bad.  As insolvency leads to bankruptcy.  The trend from Q1 to Q2 was good.  Their debt ratio fell.  But it rose between Q2 and Q3.  Rising above 1.  Which is a great cause for concern.  It fell between Q3 and Q4 but it was still below one.  Is this a problem?  It’s starting to look like it is.

There is no such thing as a Sure Thing for a Small Business Owner

Are they going to have trouble servicing their debt?  There are ratios for this, too.  Such as the Times Interest Earned (TIE).  Which shows how many times your recurring earnings can pay your interest costs.  In this example we have normal interest expense such as that paid on the business line of credit.  And the capitalized interest such as the interest portion on a car payment.  We calculate TIE by dividing recurring earnings by total interest expenses.

Trend Analysis Long-Term Debt Times Interest Earned

In Q1 their recurring earnings had no trouble covering their interest expenses.  In Q2 recurring earnings grew as did their ability to pay their interest expenses.  But the trend following Q2 has been downward.  Either indicating a surge in debt.  And interest due on that debt.  Or a fall in recurring earnings.  In this case it was a fall in earnings.  Which plummeted following Q2.  Looking at another ratio we can see the extent of these poor earnings on their long-term debt-paying ability.  If we divide Total Liabilities by Owner’s Equity we get the debt to equity ratio.  If this number is 1 then the business is financed equally by debt and equity.  If it’s less than 1 more equity (typically produced by recurring earnings) than debt financed the business.  Which is preferable as equity financing doesn’t incur any costs or risk.  If it’s greater than 1 it means more debt than equity financed the business.  Which is not as preferable.  Because debt-financing incurs costs.  As in interest expense.  And risk.  The greater the debt the greater the interest.  And the greater risk that they may not be able to repay their debt.  Which could lead to bankruptcy.

Trend Analysis Long-Term Debt Debt to Equity Ratio

This business was highly leveraged in Q1.  With virtually all financing coming from debt.  Probably because the owner drew a lot of money out during some profitable years.  Something banks don’t like seeing.  They like to see the owner sharing the risk with the bank.  If they don’t it can be a problem if the business owner wants to borrow money.  Which this one did in Q3.  Because business was doing so well this owner wanted to expand the business by adding another piece of production equipment.  But being so highly leveraged the owner had to put up a sizeable down-payment to get a loan for this new piece of production equipment.  As can be seen by the $20,000 owner contribution in Q3.  There was also a large decline in Owner’s Equity in Q3.  Indicating a one-time charge or correction.  With the loan the owner increased production.  And was looking forward to making a lot of money.  Which was not to happen.  For the economy fell into recession in Q3.

Sales fell just as they increased production.  Which led to a swelling inventory of unsold goods.  Worse, the recession was hurting everyone.  As can be seen by the growth in accounts receivable.  Because people were paying them slower they were paying their suppliers slower.  As is evident by the growth in their accounts payable.  Then a piece of equipment broke down.  They had no choice but to replace it.  Requiring another equity infusion of $10,000.  While some write-downs of bad debt reduced Owner’s Equity further.  (Or something similar.  With such low recurring profits by the time you add in other one-time and non-recurring costs this can lead to a net loss.  And a decline in Owner’s Equity.)  Despite this $30,000 equity infusion into the business the debt to equity ratio soared between Q3 and Q4.  Showing how poorly recurring operations were able to generate cash after that expansion in Q3.  Which explains their insolvency.  And as leveraged as they are it is very unlikely that they are going to be able to borrow money to help with their pressing cash needs.  Meaning that the decision to expand in Q3 may very well lead to bankruptcy.

This is just an example of the myriad concerns a small business owner has to consider before making a decision.  And a successful small business owner always has to factor in the possibility of a recession.  It’s not for the faint of heart.  Being a small business owner.  For it’s a lot like gambling.  There is just no such thing as a sure thing.


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The Politics of Tax Rates

Posted by PITHOCRATES - December 19th, 2012

Politics 101

Cash Starved Small Businesses cannot Afford to pay a Dime more in New Taxes

America is staring at a fiscal cliff.  Thanks to the budget debt limit debate in 2011.  The US was in danger of running out of money and defaulting on their sovereign debt.  The Republicans controlled the House of Representatives.  And the House is in charge of the money.  Before increasing the debt limit the Republicans wanted to get some spending cuts to reduce the federal deficit.  The Democrats wanted to raise tax rates (letting the Bush tax cuts expire, returning to the Clinton tax rates) to reduce the deficit.  They couldn’t reach an agreement.  So they did what politicians always do when they want to run away from a problem.  Create a committee.

The so-called super-committee.  Tasked to come up with $1.2 trillion in spending cuts (over ten years) by the end of 2012.  Or else.  With the ‘or else’ being sequestration.  Automatic budget cuts in defense and entitlement spending to the tune of $1.2 trillion.  The politicians knowing how unpleasant sequestration would be were full of confidence that the super-committee would overcome hell and high water to complete their task.  Because sequestration would be so very, very unpleasant.  Of course, politicians being politicians, kept running away from that problem.  And now we’re staring into the face of sequestration.  Taxmageddon.  The fiscal cliff.  Because the Democrats want to raise taxes on everyone earning over $200,000 (single) or $250,000 (married filing jointly).  But Republicans don’t want to because that will raise taxes on the job creators.  Something that won’t make an anemic economic recovery any better.  So let’s look at the numbers and see what kind of damage we’re looking at.

President Obama’s proposal for new tax rates leaves everything at the 28% marginal rate and below the same.  He proposes increasing the 33% rate to 36%.  And the 35% rate to 39.6%.  The new rates kick in at earnings of $250,000 (all the examples here are calculated for a married couple filing jointly).  Which raises the top income band at the 28% rate.  Holding the net tax increase to only $1,115 for a small business owner with a net income of $350,000.  Which doesn’t seem that bad.  But a small business owner with a net income of $350,000 isn’t exactly rich.  Despite paying income taxes like they are rich.  For most small business owners are S corporations or LLCs.  With their net income passing through to their personal income tax return.  So if the business owner lives on enough to equal two incomes (say $75,000 X 2 = $150,000) so his or her spouse can be a stay-at-home spouse that $1,115 comes out of $107,045 ($350,000 – $92,955 – $150,000).  Which is all they can put back into the business.  To pay for new equipment (which isn’t enough for most purchases forcing them to borrow more money and go further into debt).  To repay debt.  To cover unpaid accounts receivable.  To pay for customer write-offs for an employee error on a project.  To pay for a production run that failed to meet specifications that they couldn’t sell.  To pay for inventory shrinkage (damaged, lost and stolen goods).  To pay for employee raises.  Bonuses.  To hire new employees.  Or to pay for the newly mandated Obamacare.  When you factor in all these cost issues a small business owner may face $107,045 of retained earnings is not a lot of money and leaves a very small cash cushion.  Which is why Republicans do not want to raise taxes on small business owners.

Taxing the Rich more will do nothing to Lower the Deficit

Then presidential candidate John McCain opposed then presidential candidate Barack Obama’s proposed tax rate increases in the 2008 campaign.  Saying it would raise taxes on 23 million small business owners. debunked this number saying the actual number is closer to 6 million.  So using their number the additional tax revenue from small businesses would equal about $6.7 billion.  Approximately 0.48% of the federal deficit.  Which will do nothing to reduce the deficit.  But it will take more money away from cash-starved small businesses.  So what about millionaires?  What’s their damage?  And how much will they reduce the deficit?

The proposed tax rates will increase a millionaire’s tax by $30,549.  According to the IRS there were about 119,810 tax returns filed by people earning a million dollars in 2010.  Meaning the proposed increase in tax rates would raise another $3.7 billion in tax revenue from those earning a million dollars.  Which is only 54.7% of the new tax revenue from small business owners generated by those same new tax rates.  And only 0.26% of the federal deficit.  Which will do nothing to reduce the deficit.  So what about richer people?  Will taxing richer people do anything to reduce the deficit?  Let’s look at the numbers for someone earning $5 million.

Someone earning $5 million will pay an additional $214,549 in taxes.  Which is a huge increase.  But according to the IRS there were only 16,574 people who earned $5 million.  Which brings the total increase in tax revenue to only $3.6 billion.  Which is a $100 million less than the millionaires.  And only 0.25% of the federal deficit.  Meaning it will do nothing to reduce the deficit.  Even though they are taking an additional $214,549 away from each person earning $5 million.  That’s a lot of money from each person that results in no significant deficit reduction.  Which is the purpose of the higher proposed tax rates.

We’re simply Spending More than our Tax Revenue can ever Hope to Pay For

Crunching these numbers further we find that the proposed higher tax rates will increase tax revenue by $38.2 billion for everyone earning a million dollars and more based on 2010 IRS tax information.  Which is only 2.7% of the federal deficit.  Which is less than the automatic increases included in baseline budgeting.  Which means these proposed tax increases won’t do anything to reduce the deficit.  In fact the deficit will still grow larger.  Thanks to baseline budgeting.

The problem is that there aren’t enough rich people to tax.  The top 10% of earners are already paying 70% of all federal income taxes.  To raise new tax revenue you have to go to the middle class.  Based on the IRS there were 44,637,653 people filing income tax returns who earned between $50,000 and $200,000.  If each of these people paid an additional $1,115 like those small business owners that would raise an additional $49.8 billion in tax revenue.  Which is 3.6% of the federal deficit.  If you increased their taxes by $2,500 that would increase tax revenue by $111.6 billion.  Or 8% of the federal deficit.  Which may actually keep the deficit from growing.  But it won’t pay it down.

To get serious deficit reduction from the rich you have to take very large sums of money from them because there are so few rich people.  And even then it’s probably not possible to raise tax revenue enough to offset the automatic spending increases included in baseline budgeting.  But it’s a different story with the middle class.  Because there are so many more people in the middle class than there are rich people.  You can keep the deficit from growing by taking a far smaller amount from each of them than you would have to take from the rich.  You could even take enough to overcome the automatic spending increases of baseline budgeting to keep the deficit from growing.  But even the middle class doesn’t have enough people in it to wipe out a $1.4 trillion deficit.  Or make a dent in the federal debt.

No.  The only way to make any significant deficit reduction is with spending cuts.  Which the Democrats are steadfast against.  Because spending is their power.  It’s why people vote for them.  Which is why they will fight for increasing tax rates to the bitter end.  And never negotiate them away.  To continue the facade that new revenue can reduce the deficit.  Even though no amount of new revenue can.  Only spending cuts can.  For our spending has long since passed the Rubicon.  We’re simply spending more than our tax revenue can ever hope to pay for.  And any further increases in tax rates only reduce economic activity.  Causing the small business owners to stand fast on expanding and hiring.  Because economic growth is rewarded with punitive taxation.  So they will grow less with every increase in tax rates.  And with every increase in tax rates tax revenues will fall.  Which will lead to a downward spiral of deficits, debt, lowered credit ratings and possible default.  But anything is better to Democrats than admitting they are wrong.


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Planters, Money, Factors, Risk, Interest, Discounting, Accounts Receivable and Accounts Receivable Factoring

Posted by PITHOCRATES - November 27th, 2012

History 101

When a Factor advanced their Money to a Planter it could take up to 9 Months or more to Get it Back

It takes money to make money.  And in the early days before big banks there were few places to get big amounts of money.  Which you needed in the New World to grow large crops like tobacco.  You needed big amounts of money because it took a long time from planting a crop to getting it to market in Europe.  Planters needed money to plant, grow, harvest, bale, ship to a seaport where it then shipped by sail to a European market.  Then money from the eventual sale of that tobacco would take a couple of months to make it back to the planter.

It could take up to 9 months or more before they actually got the proceeds from the crops they grew.  And there were no large banks to provide financing for the planters.  So what did they do?  Enter rich people.  And merchant banks.  Factors.  Who advanced planters money to plant, grow, harvest, bale and ship their crops to a European market.  And when they sold those crops and the money worked its way back across the ocean it went to the factors.

But why would rich people do this?  Why would they take a risk with their money?  When they advanced their money it could take up to 9 months or more before they got it back.  A lot could happen in 9 months.  A drought could have wiped out their crop.  Insect infestation could have eaten their crop.  Fire could have destroyed the crop as it made its way to an ocean going sailing ship.  And that sailing ship could have suffered damage in a storm and sank.  So there was a lot of risk these rich people took.  So why did they?

Factors bought a Future Crop at a Discount from what they Expected it would Sell For

Well, they could mitigate some of this risk by purchasing marine insurance.  To cover the cost of their cargo in the event it was lost at sea.  But insurance policies aren’t free.  They cost money, too.  Not to mention the shipping costs to get these crops to market.  Costs that had to come out of those crops.  So there are costs.  And some work.  Back then you didn’t buy insurance or pay for transportation electronically.  People went to places and negotiated these things with other people.  People who earned wages and didn’t work for free.

Today when someone borrows large sums of money they pay interest.  Which helps to offset any costs incurred.  And let’s people earn money by loaning money.  Which provides an incentive to loan money.  Which is the only way people can borrow money.  When people are willing to loan it.  And people only loan money when it’s worth their while.  People save their money in the bank to earn interest.  They don’t put it there so others can borrow it for free.  But before large banks they needed another way to get money to people who needed it.  Which brings us back to those factors.

Factors made their money by discounting.  Which is a way of earning interest without charging interest.  When you buy a Treasury bill you are acting like a factor.  You may pay $970 dollars for a Treasury bill with a face value of $1,000.  When you redeem this Treasury bill the government pays you $1,000.  Giving you a $30 financial gain.  Which works out to an effective interest rate of 3%.  People like buying treasury securities because they are backed by the full faith and credit of the United States.  So there is little risk.  Whereas factors took a huge risk.  So they didn’t do it on any promise to pay.  They got collateral.  They bought a future crop at a discount from what they expected it would sell for.  Which became theirs.  And when that crop sold they got all the proceeds from that sale.  Hopefully they got as much as they thought it would sell for.  Or more.  But, of course, they took the risk that it might have sold for less.

Accounts Receivable Factoring is a Quick and Easy Way for a Business Owner to Raise Cash

Many small businesses will struggle to grow if they don’t offer credit.  Allowing their customers to buy things on account.  And then paying for all of their monthly purchases at one time at the end of the month.  This convenience encourages repeat customers to buy more.  And it allows them to buy things that they can sell later.  Like a restaurant owner who buys food from a restaurant supplier.  After selling prepared meals in his or her restaurant customers pay them.  Which allows the restaurant owner to pay his or her restaurant supplier at the end of the month.  A system that works well.  And benefits both supplier and customer.  That is, as long as people are dining at that restaurant.

But sometimes people stop going to restaurants.  And stop buying from other businesses.  Making it difficult for these businesses to pay their bills.  So they start paying their bills slower.  Instead of paying them in full at the end of the month they may take an extra month.  Or two.  So businesses who sold things on account have a growing list of outstanding invoices.  Or accounts receivable (A/R).  They print out their A/R aging report and they slowly see their open invoices go from 30 days to 60 days to 90 days.  Leaving them short of cash to pay their own bills.  And if they already maxed out their credit line they may be unable to borrow money.  So what other option do they have?  Here’s a hint.  Most of their outstanding accounts receivable will eventually become cash.  In time.  All they need is a way to get someone else to wait for that time to pass.

What they need is a factor.  Someone to buy their accounts receivable.  Giving them the cash they need.  While the factor will then pursue the collection of those outstanding invoices.  Most of which the customers will pay.  And it’s these invoices a factor will buy at a discount.  The small business owner loses some profit but they make up for that by getting the cash they need to pay their bills.  Accounts receivable factoring is a quick and easy way for a business owner to raise cash.  For unlike a loan there is no review of a company’s assets and liabilities.  No collateral to pledge.  No financial statement analysis.  For the owner is selling an asset.  His or her accounts receivable.  Which is the only thing a factor looks at.  The quality of those receivables.  Which they converted into cash.  Giving business owners the money they need to get back to the business of making money.  Much like those planters did in colonial America.


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Labor Costs

Posted by PITHOCRATES - November 19th, 2012

Economics 101

Small Business Owners may have Nicer Homes but Chances are they are Mortgaged to the Hilt

A lot of people think business owners are cheapskates.  Greedy bastards.  Who hate their employees.  And try to pay them as little as possible.  Not for any business reasons.  But just because they are so greedy.  And hateful.  During bad economic times when the employer has to make some cuts labor leaders will tell the rank and file don’t believe the employer.  “Just look at the house the boss lives in.  And the house you live in.  Whose is better?  Bigger?  That’s right.  The boss’ house is.  Always remember that.”

Yes, bosses may have nicer homes.  But chances are they are mortgaged to the hilt.  Not to mention the fact that these bosses may be working an 80-hour week.  Which is not uncommon for a small business owner.  Especially during bad economic times.  As they may be negotiating with creditors, their banker, their vendors, keeping their customers happy and trying to find new customers.  While the rank and file work their 40 hours, collect their paychecks and enjoy their free time.

So it’s not easy being the boss.  That’s why so few people want to be the boss.  For it’s easier being an employee.  You work.  You get paid.  And you leave work at work.  Even if you think you’re not being paid as much as you deserve to be.  Something most employees feel.  That they’re overworked.  And underpaid.  But they never look at things through their employer’s eyes.  And see what they really cost their boss.

Most Businesses have gone from a Defined Benefit Pension Plan to a Defined Contribution 401(k)

What an employee gets paid and what an employer pays for that employee are two different things.  To begin with an employer pays for more hours of an employee’s time than he or she actually works.  When you factor in vacation time, holidays and sick days an employer may pay for 2,080 hours while the employee only works 1,896 hours.  If an employee makes $35 an hour those nonworking hours can add up to $6,440.  Which an employee gets for doing nothing.  We call them fringe benefits.  Just an employer’s way of saying, “Hey, I don’t hate you.  Here’s some money for doing nothing.”

Why do they pay this?  Because of free market capitalism.  If they don’t pay it someone else may.  And attract their good workers away from them.  Because if there is something employees will do is jump ship the moment they get a better offer.  Which is a good thing.  This is supply and demand.  And despite workers feeling overworked and underpaid this free market dynamic makes sure employees get paid as much as they can while helping employers pay as little as they can.  That equilibrium point where employees will keep working.  While leaving employers still competitive.  Though that’s getting harder and harder to do these days.  As the cost of doing business has never been higher.

In addition to these fringe benefits there are also health insurance, life insurance and retirement contributions.  With health care often being the greatest single employee cost to a small business owner.  Which is why most now make employees pay a small portion of their health care these days.  Retirement contributions have also gotten very costly.  Few people still have a defined benefit pension plan these days.  Typically an owner will offer a defined contribution 401(k) for the employee to contribute to.  And if times are good the employer may match their contribution up to a certain amount.  But employers will call this a discretionary contribution.  And it will be one of the first things to go when they are having cash flow problems in a bad economy.

The Last Thing a Business Owner needs while trying to Deal with Soaring Labor Costs are more Costs and Taxes

In addition to fringe benefits there are payroll taxes and insurances.  Such as Social Security.  Which the employer and employee split.  At least in theory.  The employer currently pays 6.2% on the first $110,100 in an employee’s earnings.  The employee kicks in 4.2% (which may go up another 2 points after the fiscal cliff, as that tax cut expires).  In reality the employee doesn’t pay any of this.  They get their check and go on their way while the employer has to find the cash to pay the 10.4% due.  For an employee earning $66,360 that Social Security tax payable comes to $7,571.  Another big check the owner has to write is for state unemployment.  Which can be anywhere around $4,000.  The following chart summarizes these and additional labor costs (note: the retirement contribution is probably between a 401(k) matching contribution and a defined benefit pension contribution).

An employee with a pay rate of $35/hour will gross $66,360.  Deductions will lower actual take-home pay.  But the employer’s total cost for this employee in this example is $108,252.  Or an additional $41,892 than the employee grosses.  Which comes out to another $17.04 an hour.  Something the employee never sees.  This is why labor is so costly.  And why employers want to hire as few people as possible.  For each additional employee they hire (in this example) they have to pay an additional 22.2% in payroll taxes/insurances.  And an additional 41% in fringe benefits.  Or a combined 63.1%.  In addition to what they’re paying the employees for their actual work.

And this is why employers want to offload health care (especially for their retirees).  And their pension liabilities.  As they can add an additional 30% (or more) to their labor costs.  What started out as fringe benefits to attract some of the best workers is now bankrupting many companies.  People are living so long into their retirement that these cost are growing faster and larger than any other cost a business has.  And it’s also why small business owners are very worried about new regulations and taxes.  For the last thing they need while trying to deal with these soaring labor costs are more costs.  Or taxes.  Which doesn’t make them cheap or greedy.  It just makes them very cautious business owners who are trying to keep their businesses afloat in an ever more difficult business environment.


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Retained Earnings

Posted by PITHOCRATES - November 12th, 2012

Economics 101

Small Business Owners often Reinvest Everything they Earn back into their Businesses

It takes money to make money.  Before a business can make any money it has to produce something that can create revenue.  That is, they have to create something of value that people will pay money for.  To do that they have to buy land, buildings, equipment, etc., first.  They have to hire people and pay wages, salaries, benefits and payroll taxes first.  They have to spend this money before they can sell anything of value.  Because there is a time delay before the money they spend can produce anything to sell they have to get money elsewhere.  To pay all the bills.  Before they can start paying their bills from their revenue.

Small business owners often use their life savings.  They may mortgage their homes.  They may borrow money from their parents.  Or from other family.  If their capital needs are small they may use their credit cards.  And work out of their homes.  But one thing is for sure.  A small business is a cash hungry beast.  And it has a voracious appetite when it’s growing.  For those who make it to this level may be able to convince a bank to loan them money.  That can fund that growth.  Others may turn to venture capital.  If they can convince a venture capitalist that they have a great idea than can really make some money.  More advanced businesses may require even greater sums of money to fund growth and turn to the capital markets.  Using stocks and bonds to fund that growth.

Of course, it takes awhile to get to that level.  Unless you have one of those great and unique ideas.  Which can accelerate a business through this growth process.  But for most it’s a longer journey to get there.  Involving a life of sacrifice.  Skipping vacations.  Eating more hamburger than steak.  And putting off the things you want (new television, smartphone, tablet, car, etc.) until you can afford them.  Which often doesn’t come for a very long time.  Instead, small business owners often reinvest everything they earn back into the business.  To help get it to the next level.  Many small business owners don’t even pay themselves.  Because their business needs that cash elsewhere.

A lot of Small Business Owners don’t pay themselves as they Establish their Businesses

So why do they do it?  It’s not for the money.  For small business owners could make more money working for someone else without all of the headaches.  No.  They don’t do it for the money.  They do it because they’re entrepreneurs.  Filled with a passion to do something better.  Or new.  Just look at what drove Steve Jobs.  It wasn’t the money.  It was all about creating great things.  Things he couldn’t stop thinking about.  Driving some of his people crazy with his relentless push for perfection.  But he couldn’t help himself.  For he felt no inner peace until he realized his vision.  Even when his engineers and designers said what he wanted couldn’t be done.  And they kept saying that until they did what they said couldn’t be done.

This is why some entrepreneurs go ‘Albert Einstein’ in pursuit of their vision.  So focused they skip meals because they forgot to eat.  Or didn’t want to waste time by stopping to eat.  Ever try to eat lunch with a small business owner?  It can be a little on the frustrating side trying to hold a conversation.  As they never shut down.  Their mind is somewhere else.  They’re thinking about something.  On the phone.  Checking email.  Scratching notes.  These are the people that keep working the phones even when sitting on the toilet.  They’re that driven.  And we’re lucky to have such people in the world.  For they make a lot of things we like.  And create a lot of jobs.  In fact, these small business owners are the engine of job growth.  For no one creates more jobs than they do.  Not even the big corporations with billions in revenue.  It’s the small business owner who does cartwheels when they break a million in revenue.  It’s the small business with 5 employees that hires a sixth.  This is where real job growth comes from.  Because there are so many more small business owners than big corporations.

The small business owner is no stranger to sacrifice.  He or she is willing to do whatever they have to.  Even going in on the weekend and working late into the night.  While their employees are enjoying their weekend.  Spending the paychecks they earned working for the small business owner.  While the owner often doesn’t take a paycheck.  Because while he or she can sacrifice things in their personal life they need cash for their business.  For employees don’t work unless you pay them.  And if the government doesn’t get their taxes they will shut you down.  This is why a lot of small business owners don’t pay themselves as they establish their businesses.  For money they take from their businesses reduces how much their businesses can grow.  And it leaves them vulnerable to large, unexpected costs that can hit their businesses.  Or to things that can cause a drop in revenue due to something beyond an owner’s control.  Like a recession.

The Higher the Regulatory Costs and Taxes are the less Small Business Owners can Retain to Grow their Business

So when it comes to cash management small business owners are conservative.  They begged, borrowed and sacrificed to start their businesses.  And incurred substantial debt to grow their businesses.  Which only provides short-term financing.  Once they burn through that money they have to replace it with money generated by business operations.  To sustain business operations.  And to pay back those loans.  For if they don’t they can lose everything they built.  Business earnings, then, are like a fire in survival conditions.  Say you’re lost, alone and cold.  The only thing keeping you from freezing to death is the warmth from that fire.   Once started (with those bank loans) the owner has to nurture and protect that fire to keep it from extinguishing.

So how does a business make money?  They sell goods and/or services for money.  Which gives them revenue.  Then they subtract all of their costs from that revenue.  Any money left over is net profits.  Or earnings.  If they leave this money in the business these earnings become retained earnings.  That they can use to pay back those loans.  Repair old equipment.  Buy new equipment.  Pay for some advertising to expand the business.  Or even hire new employees.  If those earnings are large enough.  And recurring enough.  To give them the confidence that they will be able to pay these new costs in the future.  Provided nothing unforeseen comes up to diminish their future earnings.

But there always are.  And they’re something small business owners have to think about.  All of the time.  Especially when they think about expanding their businesses.  And hiring people.  Because that adds recurring costs.  Which is why few business owners are hiring people now.  Because of the added costs of new regulations.  The big one being Obamacare.  And higher taxes.  Especially the talk of new higher tax rates on high income people.  As most small business owners have their business earnings flow to their personal tax returns.  Even if they leave that money in their business they still have to pay taxes on it.  So while the government taxes them as rich people they’re not rich.  As they see little of their earnings.  Most of which they reinvest into their businesses.  Where it becomes retained earnings.  But the higher the regulatory costs and taxes are the less they can retain to grow their business.  And the fewer jobs they can create.  Worse, these new costs and taxes could reduce earnings to the point that they can’t pay their recurring costs.  Or service their debt.  Which could cause bankruptcy.  So small business owners are very sensitive to things like new regulatory costs and new taxes.  For they can be the difference between life and death.  If they rain down hard enough to extinguish those earnings.


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2012 Endorsements: Benjamin Franklin

Posted by PITHOCRATES - October 15th, 2012

2012 Election

Franklin understood Wealth was not Money but the Talent and Ability of the Entrepreneurs and Artisans

Benjamin Franklin was born into the middle class.  A proud member of what he called the middling people.  Entrepreneurs.  And the very definition of what it meant to be American.  Hard-working people.  Who built success based on diligence, frugality and honesty.  People who strived to live a virtuous life.  Even if they sometimes faltered.  Franklin believed doing good works led to salvation.  He believed in God and was tolerant of all religions.  Especially if they were charitable and helped others, making the world a better place.  So when he could he gave back to his community.  And to his country.  He would die a famous rich man.  But he always thought of himself as that middle class printer.  Who worked hard.  And tried to be virtuous.  Sometimes he failed.  But he did a lot of good along the way.

When he arrived in Philadelphia he had only one Dutch dollar.  He secured employment with a printer where he worked with industry and frugality.  From his first days as an apprentice.  To when he was a small business owner.  Later, on a return trip from London, he came up with four resolutions to live a better life.  1.) It is necessary for me to be extremely frugal for some time, till I have paid what I owe.  2.) To endeavor to speak the truth in every instance; to give nobody expectations that are not likely to be answered, but aim at sincerity in every word and action—the most amiable excellence in a rational being.  3.) To apply myself industriously to whatever business I take in hand, and not divert my mind from my business by any foolish project of suddenly growing rich; for industry and patience are the surest means of plenty.  4.) I resolve to speak ill of no man whatever.

When Franklin opened his own business with a partner he put in long hours.  He worked late into the evening (even working overnight when the work required it).  And started work before most others started their workday.  Being a businessman he understood money.  And the cost of borrowing.  He favored the expansion of the money supply to lower interest rates to lower the cost of borrowing for business.  However, he also understood wealth was not money.  But the talent and ability of the entrepreneurs and artisans.  Those middling people who worked with industry and frugality who offered goods and services for sale.  Purchased largely by other middling people.  The basic barter system improved by money.

Franklin believed in Limited Government and worried about too much Social Engineering

When Franklin became a newspaper publisher (i.e., writer/printer/marketer of a newspaper) he refused to become partisan.  In part because he didn’t want to limit his income.  But also for another reason.  He believed in free expression.  And said, “Printers are educated in the belief that when men differ in opinion, both sides ought equally to have the advantage of being heard by the public; and that when Truth and Error have fair play, the former is always an overmatch for the latter.”  Words framed and hung in many a newsroom since.  But he wouldn’t print everything.  He refrained from printing things that were scurrilous.  Immoral.  Or might hurt someone personally.

Franklin believed in rugged individualism.  He worked hard to acquire wealth.  And after he did he helped his community.  He helped organize volunteer fire companies.  Suggested a progressive tax on property to pay for a full-time police force.  Improved the post office.  Organized the Pennsylvania Militia during King George’s War against the French and their Indian allies in America.  (The local militia company elected Franklin to command it but he declined, saying he was unqualified and, instead, served as a common soldier.)  He retired from his printing and media empire at 42.  Set for life financially.  Then he became a scientist.  An inventor.  Then statesman.  With always an eye to detail.  And favored being practical over being rigidly dogmatic.

Franklin believed in limited government.  And had a problem with authority.  But he also believed in order.  And a place for government.  He believed in public-private partnerships and created the matching grant (matching a sum raised privately with an equal sum from the government).  He believed in charity.  Offering a helping hand.  And he was a civil activist.  Always tried to improve his community.  However, he worried about too much social engineering.  And unintended consequences.  Even worried that by helping the poor too much government could make them dependent.  And lazy.  For he built his wealth after arriving in Philadelphia with one Dutch dollar in his pocket.  It was hard work that made his success.  Not charity or dependence.

If Benjamin Franklin were here Today he would likely Endorse the Republicans in the 2012 Election

Franklin would go on to be one of the strongest supporters of Independence from Britain.  He helped edit the Declaration of Independence.  Sat in the Constitutional Convention.  And signed both documents.  As well as the Franco-American treaties bringing the French into the American Revolution.  And the Treaty of Paris officially ending the American Revolution.  He was a Founding Father.  Perhaps as indispensable as George Washington.   So if Franklin were here today what would he think about the country he helped create?  And who would he endorse in the 2012 election?

First of all he would be appalled at the size of the federal government.  Which would be unrecognizable to him from the limited government he helped create.  He would find the taxes and regulations on business suffocating to the entrepreneurial spirit.  Dissuading who knows how many from working those long hours.  Like he did.  He spent his time doing what he loved.  Printing, publishing, writing, etc.  Not hiring lawyers and accountants to help him pay his taxes and comply with regulations.  He would like the cheap credit available to business but he would have been shocked by the level of government spending and the level of the federal debt.  For the federal government is anything but frugal.  And the size of the welfare state, the amount of people receiving federal benefits, would have confirmed his fears about too much social engineering.  The blatant bias in the media would have disturbed his nonpartisan senses greatly.  Finally, being someone who rose from the middle class and built his own wealth he would have been greatly offended by the class warfare in politics today.

So who would Franklin endorse in the 2012 election?  Well, the Democrats want to make government bigger.  They want to increase taxes and regulations.  With Obamacare being a big one that will discourage many small businesses from growing.  The current Democrat administration has been the least frugal of all administrations.  Their spending having even caused a credit downgrade.  Their stimulus bill did not benefit the middling people.  Instead, most of that money went to rich Democrat donors.  They want to increase an already immense welfare state.  Which under the current administration has set a record for the number of people on food stamps.  Other than one cable channel (FOX News) and talk radio most media has a liberal bias.  Where truth and error do NOT have fair play.  And it’s the Democrats that push class warfare.  Who want to transfer even more of the tax burden to the wealthy.  Even though the top 10% of earners are already paying about 70% of the taxes.  While the Republicans want to cut taxes and regulations.  Cut spending.  Shrink the size of government.  And provide a business-friendly environment.  So others may start a business and rise up from the middle class.  Who can then give back to their community.  Like Franklin did.  So it is likely that if Franklin were here today he would endorse the party that was closer to his political and business philosophies.  The Republicans.  And the Romney-Ryan ticket.


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Jessica Alba is a Movie Star, Mother and Small Business Owner who uses Venture Capital

Posted by PITHOCRATES - September 15th, 2012

Week in Review

Jessica Alba is a movie star.  Mother.  Small business owner.  And Democrat.  She and her husband hosted the closing party at the recent Democrat National Convention in Charlotte.  So she’s pretty active in supporting her political party.  And she’s probably not a fan of Republican candidate Mitt Romney.  Probably a good thing, then, that she didn’t go to Bain Capital to raise her venture capital (see Jessica Alba: Running A Startup Is Really Hard, You Have To Be Passionate About What You Do by Sarah Perez posted 9/10/2012 on TechCrunch).

Kicking off the TechCrunch Disrupt SF 2012 sessions were The Honest Company co-founders, actress Jessica Alba and Brian Lee, also of ShoeDazzle, Teeology and LegalZoom. The two teamed up to launch Honest, an e-commerce startup offering a line of eco-friendly products for baby, family, and home. The company raised a $27 million Series A from General Catalyst, Lightspeed Venture Partners, and Institutional Venture Partners in March this year, and first experimented with the trendy subscription-based service model for selling products, later opening up to offer the ability to directly buy from the website.

Given that Honest isn’t really a “tech” startup — Lee described it as a “mission-based company” — it faces different sorts of challenges than some of the other startups in the industry. But one thing that’s not different from the rest? According to Alba, “it’s really, really, really hard” to do a startup.

“It’s so hard,” Alba said, “you’re working day and night. It actually never stops. If you’re not so passionate and working day and night, it’s not going to happen.”

She no doubt will support her party in their attacks on the evils of venture capital firms like Bain Capital even while using venture capital herself to launch a startup business.  So venture capital is bad.  Unless you need some yourself.  Then of course it’s okay.  Just hope that her venture capital firm doesn’t bankrupt her business.  And throw all of her employees out of a job.  Putting them on the streets with no health care.  For if you listen to the Democrat campaign ads that is a very real possibility.

She probably should be more careful in her remarks, too.  For she did not credit the role of government or their roads and bridges in the making of her business.  She seems be taking full credit for working day and night.  And being passionate.  Almost as if she’s building this business herself.  If she’s not careful her party may reprimand her for suggesting that small business owners build their own businesses without the help of government.  Or by winning life’s lottery.  Which of course is preposterous according to the Democrat Party.

Jessica Alba is now a small business owner.  The backbone of this county.  Let’s wish her nothing but success so her business grows and creates jobs.  Lots of them.  So she can experience the joy of complying with some regulatory policy like Obamacare.  Boy, will that be an eye opener for her.  It could very well change her political affiliation.  As most small business owners tend to vote Republican.  Even the ones who start out as Democrats.  Because once they experience what it’s like doing business under the anti-business policies of the Democrat Party they tend to have a political realignment.


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Look Out – Here Comes the Middle Class Tax Hike

Posted by PITHOCRATES - September 25th, 2010

A Little Business Primer

Who hires more people?  Big corporations?  Or small businesses?  Some may be surprised to learn that small business provides the majority of American jobs.  Little guys taking a risk.  Doing something they love.  Are good at.  They earn a living.  And provide jobs with benefits for others.  Not too shabby.

These people start their own construction company.  Buy a restaurant (from a lunch counter to a fancy place with table cloths and a wine steward).  Captain a fishing boat.  Move up from fixing cars in a backyard to operating a three-bay service garage.  Open a multi-chair hair salon.  Run a landscaping business (and snow removal business in the winter).  Sell ice cream to tourists from an independently owned Ben & Jerry’s on the strip.  Or buy and operate a McDonalds, Pizza Hut, Dunkin’ Donuts, Kentucky Fried Chicken, Taco Bell, etc.

These are not fat cats running fortune 500 corporations.  They’re no Donald Trump.  So they keep things simple.  And yet protect themselves.  They operate as an ‘S’ corporation.  This is sort of a hybrid between the regular ‘c’ corporation and a partnership.  There’s limited liability (you limit your losses to only what you invested into your business).  And there’s no business tax on earnings like in a partnership.  All earnings are distributed to the shareholders (which could be just one person).  And taxed as personal income. 

I Will Not Raise Taxes on Anyone Earning Under $250,000

Sounds good.  Stick it to the rich fat cats.  But who else makes more than $250,000?  I’ll give you a hint.  Reread the previous section.

A small business owner operating as an ‘S’ corporation is likely to earn more than $250,000.  But they’re not fat cats.  Far from it.  Let’s pick a number.  Something you think is fair for a business owner’s salary.  Someone who probably has his or her house mortgaged to the hilt.  Works 7 days a week and puts in on average 80 hours each week.  If they could earn, say, $75,000 working for someone else, would you begrudge them earning, say, $100,000 working for themselves?  For the sake of the argument, let’s say you don’t.  That’s less than half of the $250,000 tax threshold.  The small business owner, the generator of American jobs, should be safe from any Obama tax hike, right?  Wrong.

As a business struggles to grow, a business owner plows most of their earnings back into their business.  To buy a new copier.  Replace a furnace.  Buy new software.  New computers.  A network for your computers.  Inventory tracking.  A new delivery truck.  Decals for your new delivery truck.  Building signage.  A ‘yellow pages’ ad.  New telephones.  A new website.  New invoicing software with a custom-designed invoice form.  Etc.  But before you can spend this money, you have to earn it.  And, once earned, an ‘S’ corporation small business owner pays taxes on it.  Even if they invest it back into the business.  So, the higher the tax rate, the less they can grow.  And the fewer jobs they can create.

The Obama administration keeps bitching about the greedy bankers and big corporations who are sitting on their cash.  (And they sit on their cash for good reason.  They already have excess capacity.  So there’s no reason to expand.  Because there’re no markets to expand into).  The one area, though, where there may be expansion possibilities is in small business.  Raising taxes on those earning over $250,000 per year, though, will kill small business growth.  Kill jobs.  And prolong this recession.  So why do they persist in attacking the ‘rich’?  Because in terms of voters, they’re less of them than those earning under $250,000.

Playing the Numbers

The Bush tax cuts expire at the end of this year.  If Congress doesn’t extend them, taxes will go up and the economy will tank even further.  And Obama will have violated his no tax rate increase for anyone earning less than $250,000 pledge. 

But there will be no vote before the midterm elections.  (See Congress Punts on Taxes by Martin Vaughan and John D. McKinnon at the Wall Street Journal on line.)  The Republicans want to extend them across the board.  This is a problem for Democrats.  If they do, it endorses George W. Bush’s economic policies and discredits their own.  And angers the liberal base.  They would rather extend the cuts only for the middle class.  This, however, won’t help the small business owners (i.e., the job creators).  So the Republicans are opposing this as it will not help the economy. 

Let’s look at the numbers.  Note the chart at the bottom of the Wall Street Journal article referenced above.  Especially the fine print.  It reads, “2008 tax year, an additional 25% of filers are in the 0% rate category.”  In other words, 25% of the voters pay no federal income taxes.  If you add that figure to the sum of the top three ‘Pct. of filers’ in that chart it equals 95.1%.  In other words, approximately 95.1% of voters earn $140,550 or less.  Only 4.9% of the voters earn more.  Hence the class warfare.  And after stirring up the masses (the 95.1%) to hate the rich (the 4.9%), they have no choice but to keep on hating.  I mean, they can’t tell the 95.1% that they were wrong, can they?  Especially when the poll numbers are moving against them.

So, of course, the Obama administration sticks to the time-honored playbook.  And attacks the rich.  In hopes of persuading enough of the 95.1% to forget about results and to just vote their hate.  We call it playing the numbers.  There’s only one problem.  Most of the 95.1% work for the 4.9%.  So if you make it too costly for the 4.9% to expand and create jobs, they won’t.  They may even cut back.  And the 95.1% are the ones who will suffer.  They may see a reduction in their benefits.  Work longer hours (because their boss can’t afford to hire a new employee). They may even lose their job.  And their house.  They may not like that.  But at least they can find solace in their hate.


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