Acuity Advisors

Profits: How low can you go?

If your profits are falling compared to revenue and assets, your financial statements may provide insight into what’s happening and how to improve your performance.

Watch for red flags

As you sell more and invest in additional assets, profits should, in theory, increase by a proportionate amount. However, that’s not always the case. Ratios to watch for a decline include:

Gross profit [(revenue – cost of sales) / revenue],
Net profit margin (net income / revenue), and
Return on assets (earnings before tax / total assets).

For all three profitability ratios, look at two key elements: changes between accounting periods and differences from industry averages.

Identify possible causes

If these ratios are declining, it’s important to find the cause. If the whole industry is suffering, the decline is likely part of an external trend. If the industry is healthy, yet a company’s margins are falling, perhaps management has lost its control of costs — or maybe vendor or receivables fraud is to blame. To find the root cause, it’s often helpful to study the main components of the income statement.

Revenue. If the top line (gross sales or revenue) has declined, your overall profit margin will fall because there is less revenue to spread fixed costs over. To determine if this trend is company-specific or industrywide, look at revenue trends of public companies in the same industry. Also, monitor trade publications, trade associations and relevant online sources for information.

Cost of goods sold. This category of expenses is a function of raw materials, labor and overhead elements. Direct materials and labor should be controllable and historically represent a consistent percentage of revenue.

Overhead is mostly fixed and shouldn’t significantly increase unless the company has made changes (for example, purchased new equipment, changed its depreciation policy, or relocated its production facility). Examine those elements to determine whether overhead is increasing or decreasing and how the ebb and flow applies to the gross margin, which is simply revenue minus cost of goods sold.

Selling and administrative costs. Check whether selling and administrative cost items increased significantly. This section of the income statement can also be revealing if you’re trying to determine whether a profit margin decline arose from deteriorating industry conditions or weak management.

Find clues in your financials

Need help solving the mystery of your disappearing profits? Our auditors can use your financial statements to help compute financial statement ratios, identify problem areas and find solutions to get your performance back on track.

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A review of significant TCJA provisions affecting small businesses

Now that small businesses and their owners have filed their 2017 income tax returns (or filed for an extension), it’s a good time to review some of the provisions of the Tax Cuts and Jobs Act (TCJA) that may significantly impact their taxes for 2018 and beyond. Generally, the changes apply to tax years beginning after December 31, 2017, and are permanent, unless otherwise noted.

Corporate taxation

Replacement of graduated corporate rates ranging from 15% to 35% with a flat corporate rate of 21%
Replacement of the flat personal service corporation (PSC) rate of 35% with a flat rate of 21%
Repeal of the 20% corporate alternative minimum tax (AMT)

Pass-through taxation

Drops of individual income tax rates ranging from 0 to 4 percentage points (depending on the bracket) to 10%, 12%, 22%, 24%, 32%, 35% and 37% — through 2025
New 20% qualified business income deduction for owners — through 2025
Changes to many other tax breaks for individuals — generally through 2025

New or expanded tax breaks

Doubling of bonus depreciation to 100% and expansion of qualified assets to include used assets — effective for assets acquired and placed in service after September 27, 2017, and before January 1, 2023
Doubling of the Section 179 expensing limit to $1 million and an increase of the expensing phaseout threshold to $2.5 million (these amounts will be indexed for inflation after 2018)
New tax credit for employer-paid family and medical leave — through 2019

Reduced or eliminated tax breaks

New disallowance of deductions for net interest expense in excess of 30% of the business’s adjusted taxable income (exceptions apply)
New limits on net operating loss (NOL) deductions
Elimination of the Section 199 deduction, also commonly referred to as the domestic production activities deduction or manufacturers’ deduction — effective for tax years beginning after December 31, 2017, for noncorporate taxpayers and for tax years beginning after December 31, 2018, for C corporation taxpayers
New rule limiting like-kind exchanges to real property that is not held primarily for sale (generally no more like-kind exchanges for personal property)
New limitations on excessive employee compensation
New limitations on deductions for certain employee fringe benefits, such as entertainment and, in certain circumstances, meals and transportation

Don’t wait to start 2018 tax planning

This is only a sampling of some of the most significant TCJA changes that will affect small businesses and their owners beginning this year, and additional rules and limits apply. The combined impact of these changes should inform which tax strategies you and your business implement in 2018, such as how to time income and expenses to your tax advantage. The sooner you begin the tax planning process, the more tax-saving opportunities will be open to you. So don’t wait to start; contact us today.

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Effectively communicating with the audit committee

CFOs and other executives occasionally present information about the company’s operations, strategies and risks to the audit committee. Your presentation will generally be most effective if you fully understand the committee’s role, you’ve already established relationships with committee members and you focus on the most relevant information. Here’s how.

The audit committee’s role

Audit committees act as gatekeepers over financial reporting. This means overseeing the accounting and financial reporting process.

In addition, the audit committee pays close attention to how a company manages risk and ensures compliance with relevant laws and regulations. The committee also evaluates whether the company’s control environment — including its internal and external audit processes — are effective.

Bridge building

With so much on their plate, the audit committee needs clear and concise reports and presentations that provide insight over raw data. To ensure your presentation resonates with committee members, ask for pointers from other executives who have experience presenting to the committee.

It’s also a good idea to learn about the background of each committee member by reviewing their employment history, board appointments, and previous speeches or articles. Try to schedule time with the committee chair to establish a relationship and learn what matters the most to the committee. Time permitting, and with the approval of the chair, you can meet with each member of the committee to learn and address their concerns during your presentation.

Focused attention

Throughout your presentation, focus on the critical issues that require input from audit committee members. Save the details for the written materials submitted to members prior to the meeting.

The goal of written or verbal communication is to help committee members improve their understanding of the issues that fall within the scope of the committee’s responsibilities. To achieve this goal, provide sufficient detail to educate them, but avoid minutiae. Anticipate the type of questions committee members might ask — and, if you receive a question you can’t answer with confidence, follow up later with a timely, relevant response.

Immediately after your presentation, document what you learned, including individual committee member reactions and areas of interest. Doing so can help you prepare for the next presentation.

Team effort

An educated audit committee is an effective audit committee. Our team of external auditors is experienced in communicating with audit committee members about financial reporting matters and internal controls. If you’re unsure how to connect with members of your audit committee, we can help you tailor your communications.

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TCJA changes to employee benefits tax breaks: 4 negatives and a positive

The Tax Cuts and Jobs Act (TCJA) includes many changes that affect tax breaks for employee benefits. Among the changes are four negatives and one positive that will impact not only employees but also the businesses providing the benefits.

4 breaks curtailed

Beginning with the 2018 tax year, the TCJA reduces or eliminates tax breaks in the following areas:

1. Transportation benefits. The TCJA eliminates business deductions for the cost of providing qualified employee transportation fringe benefits, such as parking allowances, mass transit passes and van pooling. (These benefits are still tax-free to recipient employees.) It also disallows business deductions for the cost of providing commuting transportation to an employee (such as hiring a car service), unless the transportation is necessary for the employee’s safety. And it suspends through 2025 the tax-free benefit of up to $20 a month for bicycle commuting.

2. On-premises meals. The TCJA reduces to 50% a business’s deduction for providing certain meals to employees on the business premises, such as when employees work late or if served in a company cafeteria. (The deduction is scheduled for elimination in 2025.) For employees, the value of these benefits continues to be tax-free.

3. Moving expense reimbursements. The TCJA suspends through 2025 the exclusion from employees’ taxable income of a business’s reimbursements of employees’ qualified moving expenses. However, businesses generally will still be able to deduct such reimbursements.

4. Achievement awards. The TCJA eliminates the business tax deduction and corresponding employee tax exclusion for employee achievement awards that are provided in the form of cash, gift coupons or certificates, vacations, meals, lodging, tickets to sporting or theater events, securities and “other similar items.” However, the tax breaks are still available for gift certificates that allow the recipient to select tangible property from a limited range of items preselected by the employer. The deduction/exclusion limits remain at up to $400 of the value of achievement awards for length of service or safety and $1,600 for awards under a written nondiscriminatory achievement plan.

1 new break

For 2018 and 2019, the TCJA creates a tax credit for wages paid to qualifying employees on family and medical leave. To qualify, a business must offer at least two weeks of annual paid family and medical leave, as described by the Family and Medical Leave Act (FMLA), to qualified employees. The paid leave must provide at least 50% of the employee’s wages. Leave required by state or local law or that was already part of the business’s employee benefits program generally doesn’t qualify.

The credit equals a minimum of 12.5% of the amount of wages paid during a leave period. The credit is increased gradually for payments above 50% of wages paid and tops out at 25%. No double-dipping: Employers can’t also deduct wages claimed for the credit.

More rules, limits and changes

Keep in mind that additional rules and limits apply to these breaks, and that the TCJA makes additional changes affecting employee benefits. Contact us for more details.

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Public vs. private companies: When should different accounting rules apply?

Small private companies often criticize the Financial Accounting Standards Board (FASB) for writing overly complex standards that focus on the needs of stakeholders in large public companies rather than “Main Street” businesses. Here’s how the FASB has addressed these criticisms in recent years.

A shifting mindset

In 2012, the FASB formed the Private Company Council (PCC). This panel of private company accountants, auditors and analysts of private company financial statements advises the FASB about the financial reporting needs of private companies.

Thanks to recommendations from the PCC, the FASB has reduced certain disclosure requirements for private companies and often gives them extra time to comply with new accounting standards.

Limited exceptions

The FASB has been less open to allowing differences in the recognition and measurement of a transaction, asset, liability or instrument. In general, the FASB prefers having one set of rules that all businesses can apply to help stakeholders compare financial statements from various organizations.

However, the FASB has made some concessions over the years, including these four alternative reporting options:

1. Accounting Standards Update (ASU) No. 2014-02, Intangibles — Goodwill and Other (Topic 350): Accounting for Goodwill. Private companies can elect to amortize goodwill over a period not to exceed 10 years, rather than test it annually for impairment.

2. ASU No. 2014-03, Derivatives and Hedging (Topic 815): Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps — Simplified Hedge Accounting Approach. Nonfinancial institution private companies can elect an easier form of hedge accounting when they use simple interest rate swaps to secure fixed-rate loans.

3. ASU No. 2014-07, Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements. This option simplifies the consolidation reporting requirements of lessors in certain private company leasing transactions.

4. ASU No. 2014-18, Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. Private companies are exempt from recognizing certain hard-to-value intangible assets — such as noncompetes and certain customer-related intangibles — when they buy or merge with another company.

In June 2017, the FASB issued Proposed ASU No. 2017-240, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. This alternative would expand ASU 2014-07 by allowing private companies to avoid the consolidated reporting requirements for a wider range of transactions. The FASB is currently redeliberating this proposal, and no effective date has yet been announced.

Work in progress

The FASB plans to continue considering whether privately held businesses need simpler accounting standards compared to public companies. Contact us for the latest developments on the consolidation proposal and other financial reporting alternatives that could simplify financial reporting for your private business.

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