Four smart end-of-year planning strategies to help business owners manage cash flow, taxes, diversification, and long-term goals.
It is the time of year when many business owners start to think about end-of-year planning for the next fiscal year. Having a financial plan can help business owners to focus on their long-term goals. What strategies should business owners be thinking about in considering end-of-year planning? Following are four to consider.
1. Take stock.
End of year presents a perfect opportunity to assess your current financial position, including cash flow and net worth. Consider your corporate cash management and your personal finances in an annual assessment. Your personal and business accounts should be delineated from each other and be invested differently. Looking at liquidity, longevity, and legacy is a good way to individually assess your personal accounts and corporate side balance sheet. Consider:
- Liquidity – this should include the assets you are likely to require for immediate needs. These assets may often be held in cash, money markets, treasuries, and fixed income vehicles that can be more easily converted to address needs. On a personal front, for instance, while many investors have looked to four percent money markets in the past year or two, with short term rates are coming down, there may be other options that can offer better returns.
Regarding corporate cash management, business owners might want to consider liability driven investing or looking to match timing of assets, cash flows and yields to liabilities. While businesses need to have liquidity for expenses like payroll and cost of goods, they might take advantage of investing funds not immediately needed (such as for profit sharing and taxes at the end of the year) to allow them to potentially earn higher yields before that time.
- Longevity – these are longer-term assets, such as savings, investments in equities, etc., to cover financial needs for the next five or more years. These assets are important to ensure a “buffer” to help insure you and your family against risks such as market volatility, unexpected medical expenses, and other longer-term expenses. Having awareness of and access to longer-term assets is important in being able to overcome changing market conditions and in planning for selling a business or retirement.
- Legacy – or what you wish to leave to the next generation or to give back to others. In examining and determining your legacy strategy, business owners may be able to gain greater control over their financial futures and what they are able to leave behind, through planning and growth-oriented strategies. You may also want to consider timing donations for tax efficiency, while also supporting philanthropic goals.
While business owners should consider their personal and business balance sheets based on the above three factors, when it comes to personal finances, longevity and legacy might be most important. On the corporate side, liquidity might be the greater focus.
A good rule of thumb for business owners is to have about two to three years’ worth of expenditures in liquid assets on average for their businesses. For personal expenses and needs, they may want to have enough savings for at least six months. Business owners might also consider revolving credit facilitates that could be tapped for cash needs in looking at liquidity “buckets”.
2. Ensure diversification.
Entrepreneurs often have much of their wealth tied up in their businesses, and may be more challenged to diversify over others, as a result. While investments in one’s business can generate significant returns, having too large a percentage invested can also have drawbacks. Any individual business, no matter how skillfully run, is exposed to risks that could lead to business failure and loss of wealth.
Overall, business owners should hold more liquidity than average investors. A business is an asset that can also present a lot of risk (just as athletes, actors, and others hold professions that can be “risky” from an income perspective). Hence, it is important for business owners to hold more liquidity overall. Cash is often necessary in an emergency or to be able to pursue opportunistic projects. Some note that cash is more stable than stocks, which can swing in price day-to- day. But, often a mix of instruments, including stocks, high quality bonds, and even some alternative investments, which might gain value when the stock market drops, can provide the best investment options.
Business owners might want to also consider additional diversification strategies, such as.
- Purchasing or investing in another venture that is competitive or synergistic in nature with the existing business or in a different industry. Investing in or purchasing another business has the potential to offer another revenue stream. Simultaneously, it can introduce new risks and can also reduce diversification if it is too concentrated in the existing industry. Therefore, it is important to weigh all aspects.
- Considering stocks with the potential for higher returns. Often, just a few changes can be made to build a more diversified portfolio. Entrepreneurs with mature businesses will likely have different portfolio needs than those with a fast growing longer investment horizon so speaking with a financial advisor about your risk profile is important.
- Regularly updating your portfolio based on the current state of your business. What changes has your business made over the past year? Business owners should consider their portfolio exposure in regions, countries, and sectors alongside those in which their business is significantly exposed. They can then assess investments that are less correlated with their business(es) to help to ensure greater diversification.
3. Prepare for taxes.
From assessing capitol gains and losses, timing of claiming various deductions, deferring income, etc.– planning is an important part of optimizing tax outcomes. Tax rules can change every year and vary from state to state. It is important for business owners, therefore, to consult a tax professional throughout the year to anticipate expected expenditures and avoid risks in the business’ current tax position.
Whether you are operating as a C-Corp or S-Corp, sole proprietorship, or partnership, a tax professional can review your entity structure to ensure it is the most tax-efficient option. They can also help to ensure that you are taking advantage of potential write-offs, like the 20% Qualified Business Income (QBI) deduction alongside income thresholds that might impact this and other applicable deductions. They can work with business owners to assess Qualified Small Business Stock (QSBS) to determine if the business qualifies as well as inform business owners of any recent updates with them.
If you don’t already have a retirement Plans for your business, you might want to consider establishing a SEP IRA, Solo 401(k), or SIMPLE IRA to allow larger tax-deductible contributions for your employees and yourself.
Finally, what should be left on the company balance sheet versus the personal balance sheet (especially for C-Corps and others)? This is another important aspect that tax professionals should be able to assist with.
4. Planning for the year ahead and assessing what you want from your business in the future.
End of year is a good time to reflect on wishes for your business and personal life. Alongside assessing your plan for the future of your business, you might consider:
- What do I most want to accomplish in my lifetime?
- What do I want for myself and for my business?
- Who are the people that matter most to me, and what do I wish to leave them with?
- How do I plan to achieve my life’s vision?
If you think you may want to transition from your business in the next three to five years or less, it is important to start early in talking with your financial advisor. Many business owners underestimate the length of time and breadth of factors involved in the sale of a business. Long-term planning is a critical aspect toward a successful sale. Meeting with advisors early in the process may also provide more time to employ strategies to maximize proceeds from a sale on an after tax basis. Advanced income, legacy, and tax planning strategies to help reduce tax burden can all be part of the conversations. Another important step is getting your business ready to continue without you and considering how ready your company is for an external successor.
With the fast daily pace of business, prioritizing time to focus on planning for the future can be challenging. Business owners tend to be wired to focus on growing and advancing the business. However, a caution is to lose sight of prioritizing personal planning that could potentially outsize other financial impacts on revenue.
Effective planning starts with identifying the outcomes you want and then putting a deliberate process in place on how you might best achieve them, with a financial advisor.
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