Presenting financial information in an easily digestible format is essential when communicating with external stakeholders such as lenders, investors, and other strategic partners. These communications are vital to the long-term success of a business; however, it can be a struggle for many small and mid-size businesses. To help, below are three keys to successfully communicating the financial state of your business with external stakeholders.
#1 Be Concise
The easier it is for an external stakeholder to interpret results, the easier it will be for the company to achieve its desires from that stakeholder.
Banks. If you’re seeking a line of credit from a bank, it is important to distill the financial results of the company into a simple format that shows them they should lend to you. They want to know you have the cash to pay your bills. They want to know you have proven you can collect from customers. They want to see profitability that is consistent and stable. If any of these things require explanation, provide it.
Investors. Investors want to understand why and how your business can generate a return for them and provide comfort that their capital is reasonably safe.
Strategic Partners. A key strategic partner will want an understanding that they can commit resources to work with you in a manner that will be fruitful.
These stakeholders do not want to weed through a book. Furthermore, simply exporting your income statement and balance sheet directly from your accounting software is not enough. Summary narratives, graphs, charts, and reports can be very effective as they will enable the stakeholder to better interpret the financials of the business, as opposed to allowing them to develop their own conclusions.
At the same time, you do not want to show too much or too little financial information. Voluminous information will likely go unread. While not providing enough information can result in the investor or lender making incorrect assumptions about the business. If more detail is sought, it can be provided.
By making it easier to understand your business on paper, you are far more likely to get the answer that you want.
What is the business is trying to accomplish with the external stakeholder? You will have a higher rate of success if you anticipate and address the stakeholder’s questions upfront.
For banks, you need to clearly communicate why the money is being sought from the bank. What are the uses of the funds? For example, oftentimes an expansion won’t just require capital to purchase equipment, but could also necessitate additional staff, office space, etc.
The same applies to investors. Can an investor interpret in a quick read the high-level goal(s) the business is trying to achieve? Also, what are the risks involved for the business?
It is also best to take objections off the table proactively. If new competition is coming to the market, what is your plan to combat it? If opening a new market, what makes you think you can be successful there? Laying out potential obstacles tells the stakeholder that you have thought about them and gives them confidence in your business.
#3 Be Honest and Direct
This can often be the toughest of all. No one likes to share bad news. Far too many businesses choose not to communicate at all when this happens; however, when things are not going as well as planned, this is perhaps the most important time to communicate with external stakeholders. Don’t hide a bad quarter; explain what happened and what you are doing about it. Again, this demonstrates that you have a handle on the business and that there is no cause for undue worry. Every business will experience some hard times, but having your key allies informed and confident in your abilities will greatly enhance your ability to weather the storm.
We Can Help
Presenting financial information in an easily digestible format is essential in communicating with external and internal stakeholders. If you’re seeking an increased line of credit, looking for potential investors or strategic partners, or want to improve your internal reporting to management and/or board members, Signature Analytics can help. Contact us today for a free consultation with one of our CFOs.
As a business owner, you are used to facing never-ending checklists to help get your new ventures up and running. Before the first customer walks through the door, the new owner has already tackled seller’s permits, licensing, zoning, and registration, among other hurdles. Even after these boxes have been meticulously checked, businesses selling tangible personal property, and even some providing services, have another primary consideration – sales tax.
Depending on your business model, the idea of staying compliant with sales tax regulations can be overwhelming; however, if you get your shop set up correctly, compliance is relatively simple.
The following are answers to the most common questions business owners have about sales tax.
1. What is sales tax?
Typically, sales tax is an amount of money that is calculated as a percentage and added to the cost of a product or service. Retail sales receive tax, and 45 of the 50 United States enforce this rule.
2. Do I have to collect sales tax on all of my sales?
Not necessarily. If you make a sale to a customer to resides in the same state as your business, you collect sales tax. If the customer purchases from outside the state, you do not collect sales tax. For example, if your California business makes sales to California residents, you would need to collect sales tax.
Deliveries made to a state in which you do not have a physical location are generally not subject to state sales tax. However, the purchased product must be shipped directly to the purchaser’s out-of-state location and must be intended to be used outside the state. In this case, neither the purchaser nor its agent may pick up the purchased property within the state.
4. Am I supposed to charge a rate based on where the customer is located?
When determining the rate to charge, you must first learn whether you are operating in an origin- or destination-based state. California is a hybrid, modified-origin-based state where taxes of the state, county, and city are based on the source of the sale, while district taxes are based on the destination of the sale. California gives you two options in applying this; both are acceptable.
The first option is to charge the state rate plus your district rate on sales shipped within your district. For sales shipped outside your district, collect the state rate only. If you choose this option, the customer is technically liable to remit the omitted district tax to the state.
The second option is to charge the state plus the district rate for every single sale shipped to a customer in California. This process ensures that the local district tax always gets collected.
It is worth noting that collecting the same sales tax rate from every customer in California is technically wrong. If you do this, you are most likely not collecting the correct rate on every sale.
5. If the customer does not pay the sales tax, do I still have a liability?
Yes. The seller is responsible for the sales tax, not the purchaser. The law allows that the retailer may be reimbursed by charging the sales tax to their customer. However, even if the customer does not give an extra amount of money intended as “sales tax,” you are still liable for remitting the full amount of the tax.
6. If the tax I withhold is higher than the tax owed, what do I do with the difference?
Technically, if you collect more than the amount of tax due, you must either return the excess amount to the customer or pay it to the state.
7. What if the customer does not ultimately pay for the product provided?
Sales tax is imposed on completed sales, not collections. Even if the customer account becomes uncollectible, the retailer is still responsible for tax on that sale. Keep this in mind when preparing sales tax returns. If an account is not yet collected, gross receipts from the sale must be included in the tax base for sales tax purposes.
8. Are any sales exempt from sales tax?
Yes. Some common examples of exemptions and deductions include:
Sales for Resale (if supported by resale certificate or purchase order)
Some Food Products (for example, cold food sold to-go)
Labor (Repair and installation)
Sales of prescription medication
Sales to the U.S. Government
9. When are my taxes due?
Businesses are assigned a filing frequency based on the total sales tax collected. Your business may need to file monthly, quarterly, or yearly.
10. Is a sales tax return required even if my liability for the period is zero?
Yes. Every business with a sales tax license is required to file a return even though no sales were made during the period covered by the return. However, if you have seasonal sales or your sales tax liability has declined, you may request less frequent filing from the state.
Sales tax is an essential source of revenue for the state, and you should strive for full compliance in this area to avoid costly penalties and fees that result from a sales tax audit. By setting up your business early with a system that ensures correct collection and remittance of sales tax, you can avoid unnecessary expenses and fees in the future. Contact us if you need help.
The beginning of the year is anything but dull, but after the holiday celebrations, it’s time to settle down and get organized for tax season. While employees might not have taxes on the brain until April, businesses, and employers are busy preparing early on. It’s crucial to start this process sooner rather than later, so no paperwork is forgotten. One essential form to remember is 1099.
What Is A 1099 IRS Form?
A 1099 IRS form is a record of a person or an entity providing payment to someone. There are several types of IRS 1099 forms, such as 1099-MISC, 1099-INT, 1099-CAP, and more. These informational returns are used to record payments to individuals or partnerships for interest, services, bonuses, and other types of income paid during the year.
Please note that business owners must file 1099 forms with the IRS and send a copy to the individual each year by January 31st, the same as the W2 filing deadline.
If you have convertible notes payable that accrue interest during the year, you must file Form 1099-INT
If you paid dividends to inventors, you must file Form 1099-DIV
If you forgave an outstanding debt during the year, you must submit form 1099-C
All amounts paid to law firms must be reported on a 1099, regardless if the law firm is categorized as a corporation and even if the amounts are less than $600
Here Are The Accounting Best Practices for 1099s
Good recordkeeping is key to fulfilling this requirement and meeting the January 31st deadline:
Payments to vendors should be categorized in your books and records by vendor and not merely by category or expense line item.
Small businesses should always request a form W9 from any vendor with whom they conduct business. A W9 will tell you if the vendor is a Corporation (excluded from 1099 requirement) and what their federal tax ID number is (needed for the 1099). Read More:Financial Tips From Successful Leaders
These Are Common Mistakes To Avoid
Below are some examples of mistakes commonly made by small business owners when it comes to 1099 rules:
Classifying employees as a 1099 vendor when they meet the IRS definition of a W2 full-time employee.
Giving expensive gifts or prizes to sales representatives or others without issuing a 1099 for the value of the gift.
Not filing a 1099 for interest accrued on convertible notes or other bonds.
Not keeping proper records or requiring a W9, so when it comes time to prepare the 1099s they are filed late due to trying to collect all the necessary data from each vendor.
Do not wait until the last minute. Reduce the January time crunch by reviewing your vendor list with your accountant in December if you can remember. Find and address issues early and make sure you have a plan to get the 1099s filed by the January 31st deadline.
Signature Analytics Can Help
If you need help preparing the data necessary to complete your 1099s, have questions about who you should be sending this form to, or any other financial paperwork inquiries, please contact us today.
As an entrepreneur, you likely have a never-ending to-do list that includes meeting with employees, calling disgruntled customers, reviewing company finances, and more. While the list of to-dos never seems to end, you might have an idea in the back of your mind to someday exit the business you have built.
If you have plans to sell your company or a portion of it, anytime within the next 2 to 3 years, the time to start preparing is now. Do not wait until you receive your first letter of intent from a potential buyer. The more effort and time that you can give to preparing for your eventual exit, the smoother the transition can be when the time comes. You’ll likely feel that more work is piling onto your plate, but this is expected as exiting a business, via acquisition or liquidity event is always time-consuming.
Think of it as more effort now, less stress later. The more you can prepare your business for the possibility of an acquisition, the more value you are adding to the company today. Keeping in mind that the business will be better off when the time comes to transition.
Below are a few steps you can take to prepare your business from a financial perspective.
1. Allow Time to Maximize the Potential Value of the Company
From a financial standpoint, it is advised to begin preparing for a liquidity event at least two years before the potential exit. Doing so will ensure you have ample time to make changes that are necessary to improve the business and maximize the future value of your company.
While it is always important to optimize your company’s profitability and value, it is even more so if you are planning to sell. This can be accomplished by streamlining financial statements to ensure management can review them effectively.
For example, simplified and organized financials will enable you to evaluate profit margins by individual revenue stream, develop Key Performance Indicators (KPIs) and ratios applicable to your company, as well as identify and consistently report on the metrics that drive profitability and value. It is vital to begin this process in advance of any sale or liquidity event, as your management will need time to identify, implement, and benefit from the changes made.
2. Get Your Financial Records in Order
When preparing your company for an acquisition, it is critical that your financial records are well maintained. Keeping pristine financial records helps avoid any pitfalls that may be uncovered through the due diligence process.
If you believe your accounting department may not be technically strong, it is encouraged to hire an outside accounting consultant to help sort through the critical information. An independent consultant or team can ensure you’re fully prepared for the financial due diligence process. They do this by gathering information and creating a strong package of financial information that clearly explains the results of your business operations. Even if you believe your accounting department can handle this process, we recommend having a qualified consultant perform the initial review to provide an outsider’s perspective.
3. Plan Ahead with Sell-Side Due Diligence
While certainly not required, engaging an outsourced accounting firm to perform what is known as a “sell-side” due diligence (or a quality of earnings report) process could save you from significant headaches and distractions during this already stressful time.
Sell-side due diligence allows you the opportunity to go through the due diligence process in a more reasonable timeframe. Proactively doing this allows your management team more time to find, organize, and interpret the financial information. Throughout this process, leaders should identify questions that may be raised by potential buyers, so they are better prepared to respond to items in an organized manner.
The sell-side due diligence team will also identify what are known as “add-backs.” These are described as non-recurring or unrecorded revenues or expenses that are added back to the Earnings before interest, tax, depreciation and amortization (EBITDA) to generate a normalized figure. Add-backs can be subjective in nature; therefore, it’s valuable to identify them before the buyer brings them up so you can prepare how to argue for or against those items in question.
Having a prepared sell-side due diligence report could also limit the amount of investigative work that the buyer determines necessary as they may be willing to rely on some, or all, of the results of the report.
Next Step: Due Diligence
You are ready to sell your business, your financials are in order, and you have just received your first letter of intent from a potential buyer. Next, it’s time to prepare for what many believe is a terrifyingly brutal process – due diligence. Read our blog post on the financial due diligence process to learn what is required and how to prepare your business to ensure a successful acquisition.
Prepare Your Business for an Acquisition or Liquidity Event
If you have plans to sell your company, Signature Analytics can provide ongoing accounting support and forward-looking financial analysis to ensure you get the highest value for your business. Contact us for more information or a free consultation.
Clear, concise and regular reporting of financial information to all the internal stakeholders of your business is a vital, yet often overlooked, component of long-term business success. These internal stakeholders can include your management team and board of directors.
Financial Reports: The Roadmap to Reaching Your Destination
When taking a family road trip, one of the first things you do is use a map to layout the journey, locate markers along the way, identify where the destination is and how long it will take to get there. Clear, concise and timely reporting of usable financial information to internal stakeholders operates like a roadmap, but for your business for role clarity.
When putting together this “roadmap” for your business and communicating that information with internal stakeholders, there are a few important things to keep in mind:
It is essential to report information on key operating metrics and not only report on items that can be interpreted from the income statement. For example, the balance sheet and statement of cash flows can also provide important information to internal stakeholders, such as: How much cash is tied up in receivables? Have you taken on new debt? What about inventory?
Ideally, your business should have some sort of stakeholder management dashboard that summarizes all these key internal and external metrics in one place. It should also include metrics and key performance indicators (KPIs) that are unique to your business effort.
Financial information and reports should not be viewed in isolation. Rather, the information should be compared to prior periods to understand influence trends.
The owners of each metric should be able to explain the results that have occurred so internal stakeholders can understand what the results actually mean. Has inventory grown because of a new product line? Has cash increased because the company is now using a line of credit? Is employees utilization lower because the company is hiring in advance of customer growth?
Communicating financial information in an organized and easy to understand method—such as using pictures and graphs instead of a list of numbers, and showing trends to help managers visualize projections—can help increase credibility with board individuals (internally or externally) and improve meeting productivity. Take a look at a recent case study.
The combination of all these will allow the CEO and other internal stakeholders to have greater confidence in their decision-making process and enable them to make those decisions based on dispassionate financial analysis rather than a “gut feeling”.
We Can Help
Presenting timely financial information in an easily digestible format is essential in communicating with internal stakeholders. If you need professional-looking reports prepared to increase your credibility and improve meeting productivity with internal stakeholders, we can help. Contact us today for a free consultation with one of our CFOs.
There are several financial reports that will provide insight into the past, present, and future financial state of the business. As a business owner, it is critical to have an annual report of this financial data as it will allow you to more effectively run your company, enable you to better analyze operations, and help guide business decisions.
Of all the financial reports, below are five of the most essential accounting reports every business owner should be reviewing on a regular and annual basis to gain a better understanding of the company’s financial performance.
1. Balance Sheet
The Balance Sheet is a financial statement summarizing a company’s total assets (current, non-current and intangible assets), liabilities (financial obligations), and shareholders’ equity (investments and retained earnings) at a specific point in time, usually at the end of an accounting period. It provides a snapshot of a company’s financial position, including the economic resources the company owns, owes, and the sources of financing for those resources.
The Balance Sheet can be used to identify trends and make more informed financial accounting decisions. It is also important to lenders, as they will use it to determine a company’s creditworthiness.
2. Income Statement
The Income Statement is sometimes referred to as the Profit and Loss Statement (P&L), Statement of Operations, or Statement of Income. The Income Statement summarizes the total revenues and expenses incurred by the business, showing the profitability (net income or net loss) over a specified period of time, usually a month, quarter or year.
The Income Statement is used by internal stakeholders (such as the management team and board of directors) as well as external stakeholders (such as investors and creditors) to evaluate profitability and help assess the level of risk for an investor or creditor. In order to have a viable and valuable company, revenues must exceed expenses.
3. Cash Flow Statement
The Cash Flow Statement summarizes all cash inflows and cash outflows of a business over a period of time. This statement is different from the Balance Sheet and Income Statement because it only takes into account cash money activity; it does not account for non-cash activity such as sales or purchases on credit or depreciation.
The Cash Flow Statement is presented with three sections: operating, financing and investing activities, and indicates which areas of the business are generating and using the most cash. One of the best uses for the Cash Flow Statement is to estimate future cash flow which will assist with budgeting and decision making.
The Cash Flow Statement, Balance Sheet and Income Statement together make up the standard financial statement package. These financial statements should be prepared by your accounting team on a monthly basis after the month-end close procedures have been performed. They can (and should) be used to calculate key performance indicators and monitor them over time.
4. Accounts Receivable Aging Report
The Accounts Receivable (A/R) Aging Report categorizes outstanding accounts receivable into groups based on the due date of the invoice, typically current, as well as 1-30, 31-60, 61-90 and >90 days overdue.
A common source of cash flow problems (especially for small and mid-size businesses) is poorly managed accounts receivable. The more cash you have tied up in receivables due to slow-paying customers and delinquent accounts, the less cash you have available for running your business. Reviewing the A/R Aging report will help companies proactively manage the receivable collections process immediately upon invoicing and create more accountability for the person responsible for collections.
The A/R Aging Report can be generated out of most accounting systems and can be reviewed at any time. If collecting on accounts receivable is an issue for your business, a weekly review of this report may be necessary to assist in identifying past due accounts. Once these accounts are identified, collection procedures can be initiated to improve business cash flows.
5. Budget vs Actual
As the name suggests, this report is a comparison of actual results, primarily from the Income Statement, against the budgeted amounts that were projected at the beginning of the period. This report will allow the reader to assess how closely a company’s spending and revenue generation meets the financial forecasting projections included in the budget. It can help identify areas that were over and under budget, indicating the ability to hire additional employees or bringing attention to a gross profit margin not in line with financial reporting expectations, for example.
The Budget vs. Actual Report should be prepared on a monthly basis and reviewed with the financial statements to determine if any areas of the business are not meeting expectations and should be investigated further.
We Can Help
Our highly experienced accountants can complement your internal accounting employees, or act as your entire accounting department (CFO to staff accountant) on an ongoing basis. We will consistently provide you with timely and accurate financials and reports (like the ones mentioned above) on a monthly basis, as well as the actionable financial analysis you need to effectively run your company, analyze operations, and guide business decisions. If your business needs additional accounting support, contact us today to schedule a free consultation.
Crafting an annual budget is one of the most important financial aspects of a business, but often gets overlooked.
Business budget planning is an essential task that is frequently neglected at small and mid-size companies. So why is it so important? Well, mostly because it is a process that prepares your company to answer critical questions about what the next 12 months will look like:
What are you projecting sales to be next year?
Are you expecting margins to improve next year?
Do you plan to hire additional employees?
Will you have any significant capital expenditures soon?
These questions (and many others) are typical of investors, financial institutions, potential strategic partners, and financial buyers. Every business, regardless of size, should have the answers to these questions to be able to plan the annual operating budget accordingly.
Having a chief financial officer, or CFO, as part of your company’s C-Suite executive team can be an asset in this process.
A CFO will have access to and be up to date on the most recent financial data pertaining to the company. These resources can help the company craft its budget, as well as short and long-term financial goals. Strategic budgeting is a skill that any good CFO will have in their arsenal. It’s just a matter of working as a team to bring all the relevant information together to plan for the future.
If you are overwhelmed by company budgeting planning, don’t have a CFO, or don’t know where to begin, below are some tips to help you get started:
1. Consult All Departments
The annual budgeting process should not be completed behind closed doors by one member of the accounting or finance team. Instead, all the departments within the company should be part of the conversation and provide feedback, insights, and expectations for the following fiscal year.
Who should contribute to the conversation? Be sure to loop in:
The sales team: they can assist with realistic revenue assessments
The manufacturing or service team: they can advise on costs of delivery and any large purchases required to update machinery
The research and development team: they can discuss expected expenses as well as the timing on any new products anticipated
Any other departments who can add value to the conversation
It is encouraged to incorporate feedback from each department as the results are much more likely to be accurate. Therefore, project completions are possible for the upcoming fiscal year. Too often, companies that do complete the annual budget planning process estimate an overall percentage increase over the prior year’s actual income – this is something that should be avoided.
2. Estimate Revenues
Expected sales have a significant influence on costs, including employee headcount, but it can be very challenging to make projections accurately. Here are some ways to come up with the best estimate:
Consider the recent monthly growth rate experienced by the company and decide if it can be continued.
Review industry guides and other expert publications that focus on your industry.
Review financial information from a number of your competitors, if available.
Communicate with your current customers to better understand their expected needs of your product or service.
Discuss the expected sales with your sales department and set expectations to help determine compensation for this team.
3. Determine Expenses
Once the expected revenue figures are estimated, the focus can shift towards expenses. Here are some considerations:
Some costs relate directly to revenue, whether they be inventory or employee services. Typically, the gross margin of a business does not fluctuate substantially unless new products are developed, inventory prices change, or inefficiencies are identified within the manufacturing process. Use this time to challenge your employees to identify cost savings related to the delivery of products or services.
Other expenses are fixed costs such as rent, insurance, equipment leases, and certain other services purchased. These expenses may be easier to estimate; however, you should consider reviewing the policies in place, especially around insurance. Use this time to determine if better insurance rates are available or if different coverages would be more advantageous.
Employee compensation should always be established to be in line with revenues and related growth in the coming year. Many companies believe that all employees require annual raises, but if the results show a contraction in the business, then it may not be reasonable. Consider tying aspects of compensation to the growth of the company. With today’s inflationary trends, make sure you include cost of living wage increases for your employees in your budget and projections as well.
Along with compensation, estimating employee headcount is a critical aspect of the budgeting process. It is important to identify when you will need to hire, how long that hiring process takes, and what experience level would optimize the operations.
4. Identify Capital Expenditures
Often not considered in the budgeting process are those large or expensive purchases which are vital to the continued success of the business. These may include new computers, systems, machinery, vehicles, furniture, etc. It is essential to keep in mind that each new employee hired will likely require a certain amount of capital expenditure.
Investments in equipment or processes that are directly related to your product or service should also be considered. Will you need to purchase any new materials next year? Is there old equipment that needs to be updated? Avoiding investment in equipment can impact your output, quality, or delivery timing, which can directly impact your revenues.
5. Calculate Cash Flow
While putting together a projected income statement can feel great, it is just as important to calculate the expected cash flow of the business.
Your company may pay bills faster than customers pay theirs. You may need to purchase inventory well in advance of sales if acquisition time is significant. In cases such as these, a cash flow statement should be created using the income statement as well as AR/AP turnover rates and other metrics from the balance sheet.
While it may seem advantageous to show investors that the company will significantly grow, it’s a possibility that results may disappoint. Even worse, business decisions may have been made using such projections (aka best guess scenarios). When in doubt, it is a good idea to be more conservative and leave some room in the projections in case of emergency, unforeseeable large expenses, or a drop in revenue and sales.
7. Start Early
Businesses should begin the annual budgeting process three to four months before the start of their fiscal year to allow sufficient time to craft a detailed estimate before the year ends. However, the annual business budget should be monitored and updated on an ongoing basis. For this reason, it’s never too late to get started.
8. Monitor, Evaluate & Reforecast
Once you complete the budgeting process, the biggest mistake you could make is to file it away only to pull it out again at the end of the following year.
A budget should be monitored monthly, or sometimes weekly for smaller companies. Budgets should be edited if circumstances change, like bringing in more fruitful accounts or losing critical customers.
If you have a CFO on your team, they can help facilitate a strategic forecasting process that extends beyond the annual budget and encompasses more of a three-year plan. This can help push your company to think about future business decisions and goals.
Furthermore, budgets should always be compared to actual results to understand why there are differences. Doing this will help monitor spending money throughout the year and help management make important decisions in relation to the business. Put these tips into action and learn how to prepare an annual budget with our in-depth guide.
We Can Help
Signature Analytics will help guide your company through the annual budgeting process. We will work with your management team to create a budget for your business and monitor that budget throughout the year.
This would include analyzing the budgeted versus actual results quarterly and helping forecast accordingly. We can also perform industry and economy reviews to assist with the forecasting process and provide benchmarking data.
Whether you are a new business owner or one that’s been in business for years, understanding requirements of a fiscal year close can be confusing. Keeping your financial information and records accurate year-round is critical to the success of your business, and it makes things that much easier during fiscal close.
Here are the top 5 questions you should ask, as you approach the process of closing your 2015 books:
Have you recorded all your revenue for 2015?
Do you have organized processes to record expenses in a timely manner?
Does your accounting function have oversight, checks and balances to ensure your books are accurate on a monthly basis?
Have you contacted your tax professional to schedule a meeting? Definitely try to avoid the March 15th and April 15th rush!
Did you make quarterly estimated tax payments throughout 2015? If not, you should ask your tax professional if this is an option in 2016.
We Can Help
If you need assistance with your fiscal year end close, contact us today. Our outsourced accounting teams are locally based and nationally focused. We can help you with this effort, as well as other accounting and financial analysis needs of your business.
Stock options can be a great way to motivate key employees, help them feel more invested in the future of the company, and make overall compensation plans more attractive to current and prospective employees. For these reasons, it is becoming increasingly popular for companies to issue stock options to their employees.
Large, publicly-traded companies such as Starbucks and Southwest Airlines grant stock options to many, or all, of their employees. Start-ups may also grant stock options to employees who take the risk to work with the company at an early stage with the hope of large payouts once the company goes public or is purchased.
If your company is considering granting stock options to your employees, below are some best practices and considerations to keep in mind prior to rolling out an employee stock option plan.
Employee Stock Option Basics
An employee stock option is a contract issued by an employer to an employee to purchase a set number of shares of company stock at a fixed price through an established period of time.
The two classifications of stock options issued are incentive stock options (ISO)—which can only be granted to employees—and non-qualified stock options (NSO), which can be granted to anyone, including employees, consultants, and directors.
Key Considerations
As you set-up your employee stock option plan, it is important to consider the following:
Amount of ownership you are willing to dedicate to employee equity compensation.
Impact of stock options on the valuation and/or dilution of your current investors and owners of the company.
A company valuation (required under IRC 409A) will be necessary to determine the underlying price per share of your company’s stock. Typically this must be performed by an outside valuation professional on an annual basis and may be costly.
Timing and size of grants, including an expectation of future grants to current and future employees.
Accounting Implications of Stock Option Plans
Under Accounting Standards Codification (ASC) 718, companies are required to record stock compensation expense over the vesting period of the stock option grant. As this amount can be difficult to value, it is typical for companies to use an outside professional or program to calculate this expense on an annual basis.
As stock compensation is a non-cash expense, it is typically ignored by non-audited companies; however, it can be a costly and lengthy process to record past years of expense in the first year of an audit. Therefore, keeping detailed records of option grants, exercises, and employee termination dates from the beginning will greatly decrease the time required to calculate the expense and related financial statement disclosures if/when you require audited financial statements.
Options issued to consultants for services must be revalued each reporting period, thus complicating your expense further.
Implementing a New Stock Option Plan
Implementing a new equity compensation program often requires assistance from outside your organization.
Lawyers will be required to compile the plan documents and individual stock option award agreements to ensure you are meeting all legal and compliance standards.
Professional help can also be beneficial in designing and implementing your plan.
A tax professional should be consulted to ensure you are issuing options in a way most tax beneficial to your company and employees.
We Can Help
If you need assistance calculating the stock-based compensation for audit purposes, or would like to better understand some considerations for incentivizing your employees or attracting new talent, contact us today.
