How to Use Financial Gap Analysis

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A gap analysis is a tool that companies use to compare their current financial performance with their target performance. Business owners and managers can use this information to not only identify any financial gaps but to better understand how to overcome them and find the best course of action towards the company’s financial goals. The “gap” in a gap analysis is the space between where an organization is and where it wants to be in the future. Not to be confused with GAAP (Generally Accepted Accounting Principles) reporting, a gap analysis is a measure of where a business has gaps in finance, operational efficiency or other blind spots. 

The main questions a gap analysis aims to answer are: 

  • Where are we now?
  • Where do we wish we were?
  • How are we going to close the gap?

In this article, we will outline the purpose and process of a gap analysis and answer some frequently asked questions. 

Understanding Gap Analysis

A gap analysis is a method of assessing the financial performance of a business to determine whether requirements or objectives are being met and, if not, what steps should be taken to meet them. By defining these gaps, management teams can create plans to address any underperforming areas and work towards the goals of the organization.

Performance gaps can be measured across multiple areas of the business, such as revenue generation, sales processes, technology adoption, internal communication or operations processes. Gap analysis can also be used to assess the difference between liabilities and rate-sensitive assets including bank assets, bonds, loans and leases.

There are typically five basic steps to a gap analysis, which include:

  • Benchmarking the current state
  • Defining financial goals
  • Analyzing the gap data
  • Compiling a gap report and making a plan
  • Monitoring progress

When Is a Gap Analysis Necessary?

Whenever fluctuations in profitability, changes in operational efficiency or rapid growth occurs, performing the process of a gap analysis, and specifically a financial gap analysis, can bring essential insights into how a business operates to light. This information can help a company navigate a scope of financial situations, ranging from long-term strategic planning to short-term budget issues.

However, companies do not need to be underperforming to perform a gap analysis. Since these analyses are strategic in nature, business owners and managers can use them to understand aspects such as market positioning and labor needs. Further, company leaders can use this information to scale the business and/or set the organization up for long-term financial success. 

Types of Gap Analyses

Gap analyses can generally be split into two categories: strategic and operational. 

Strategic gap analysis assesses gaps in business planning and the overall organization.

Operational gap analysis, on the other hand, examines a specific project, process or day-to-day work of a team or department. 

Types of gap analysis include:

  • Financial/Accounting gap analysis
  • Product or market gap analysis
  • Strategic gap analysis
  • Skill gap analysis
  • Compliance gap analysis
  • Product development gap analysis
  • And more 

Gap Analysis Examples

Many businesses use the gap analysis process. Let’s take a look at some examples of gap analysis uses.

Gap analysis is most useful when an organization needs to: 

  • Develop a change management strategy but leadership needs to first identify the gap between the current and desired state 
  • Create a new strategy for the team and want to understand where the organization currently sits
  • Prepare for an audit and showcase how the company is proactively addressing any gaps
  • Find out why the organization isn’t meeting important key performance indicators (KPIs) and strategic objectives 
  • Identify opportunities to improve existing processes
  • Prepare a strategic plan and prioritize resources 

How To Perform a Financial Gap Analysis

A gap analysis template can be used and typically contains five basic steps to evaluate the gaps. Let’s take a look. 

Benchmark Current Financial State

A gap analysis starts by defining the state which an organization is operating at. The current situation represents an objective reality which can be measured using currently available financial data. This data serves as a baseline against which future growth potential can be measured.

For instance, if an organization wants to perform a gap analysis of profits, then the current situation would be based on the most recent annual, quarterly or monthly profits.  Financial key performance indicators are gross profit margin and operating profit margin.

Define Financial Goals

Management can use this step to define what is important to the success of the organization and their future financial goals. 

The desired financial situation is the company’s goal for the key financial metrics performance. It should be based on the same measures as the current situation; for example, if the current situation is a measure of profits, then the desired situation should also be based on profits.

Analyze the Financial Gap Data

In a financial gap analysis, the gap is measured between the current financial situation and the desired financial situation. The gap is, quite simply, the difference between the current financial situation and the desired financial situation. To evaluate a company’s financial performance start with the P&L statement and to evaluate the gross profit margin and net profit margin. This step provides an opportunity to not only identify a gap and determine its size, but also to figure out why there is a gap.

This step can help management identify the roots of any issues or underperforming areas. Business leaders can successfully analyze the financial data by:

  • Being specific about the gap. 
  • Asking questions to determine why the gap is occurring in order to determine the root of the problem. For instance: what is holding back our team from meeting the sales goals?
  • Looking through the company’s financial statements:, income statement, balance sheet, and cash flow statement to determine financial position.  

Establish a Plan

After leadership identifies the gap and determines why it is occurring, they can create a plan to address the issues  to improve the company’s financial health. In some cases, there may be a single solution for bridging the gap; in others, leadership may utilize several strategies in order to address any issues revealed by the analysis. These plans often include a detailed set of processes set at a specific cadence. 

Monitor Progress

Gap analysis should be a continuous process where after changes have been made, the company re-evaluates its current position, progress, and goals. 

 

Gap Analysis FAQs

A gap analysis is a powerful tool in strategic planning. However, many business leaders may not be sure where to start. Let’s answer some frequently asked questions.

How Do You Do Gap Analysis for your Business’ Finance and Accounting Department?

A gap analysis of your business’ finances is the same as gap analyses in other departments; the only differences are the goals and objectives assessed during the analysis. For example, in a financial gap analysis, a team might look at the company’s performance in terms of sales or revenue.

What Are the Three Fundamental Components of a Gap Analysis?

The three fundamental components of a gap analysis include: assessing the current situation, determining the goal state, and highlighting the gap between the two. Then, the organization leaders can create an action plan to bridge said gaps.

What Should a Financial Gap Analysis Include?

A financial gap analysis typically focuses on a few key elements. These elements can include, for example: 

  • Revenue
  • Cost of Goods Sold
  • Gross Margin
  • Gross Profit
  • SG&A Expenses
  • Net Income
  • Net Income Margin
  • Cash or Liquid Assets
  • Assets
  • Debt or Liabilities
  • Equity / Equity Structure
  • Free Cash Flow
  • A/R
  • A/P
  • And more

What Happens After the Gap Analysis?

Following the analysis, the leaders of an organization will have a clear picture of where the gaps in the organization are, how big the gaps are, and how management may begin to address them.

Forward progress relies on consistent work over a period of time. We recommend taking concrete measures to manage progress, such as implementing key performance indicators (KPIs). 

About Signature Analytics

Signature Analytics is the Smart Choice for business owners. With the support of our expert accounting and CFO Business Advisory services, your business can get to the next level of profitability and operational efficiency. 

Our assessments provide a deep dive into your existing accounting structures and processes and help us customize the right solution for your business. With those insights, we then bring in the right outsourced team to get you the Accurate, Relevant, and Timely financials you need to run your business successfully.

Contact our team of experts for business and financial analysis and any other questions you may have during this challenging time.

Financial Metrics: Master the Language of Business

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Business owners have access to myriad of metrics and data, but what is important? What financial metrics are the RIGHT metrics to track in order to make smarter business decisions? In this article, we review the most important financial metrics that business owners should track in order to make informed decisions in their businesses.

In a sea of data, it can be challenging to pick out the important markers that indicate a course correction or impending windfall. By tracking these financial metrics, business owners can have a canary in the coal mine or bellwether to give them insights into trends that indicate important changes that can be made to be more profitable.

To make informed business decisions, it is important to track certain financial metrics that can be found in the company’s financial statements. These include the balance sheet, income statement, and cash flow statement. By monitoring these metrics, business owners can gain insight into the financial health of their business.

What are Financial Metrics?

Financial metrics are indicators used to evaluate your business’ financial performance, position, and strengths and weaknesses. Key financial metrics  provide key statistics from financial statements to calculate your business’ liquidity, leverage, profitability, and growth potential to help you make key decisions and evaluations to improve financial performance.

Financial Metrics Help CEOs Make Better Decisions

Metrics give you an honest and in-depth look at how your business is operating so you know when and where to make changes to improve your financial position. They can also be used as tools to determine company strengths as well as benchmarks for key performance indicator objectives.

There are an overwhelming number of metrics available to business owners, so it’s important to know what your business goals are and what metrics can achieve these goals.

Core Financial Metrics You Need to Know

Liquidity, leverage, profitability, and growth are core business metrics you can identify on your company’s financial statements to ensure your business is going in the right direction. Being aware of these metrics as your business grows and develops will be critical for long-term success and financial health.

Liquidity Metrics

Liquidity metrics are used to determine if your business has enough cash, or assets that can be easily turned into cash, to pay off short-term bills. By knowing what liquid funds are available you can get a good idea of your company’s short-term financial health.

When determining your company’s liquidity, you’ll use data from your balance sheets. The two key metrics we’ll use for liquidity are working capital and current ratio.

Working capital outlines the funds you have available to pay off your short-term financial obligations. Working capital can also be valuable for planning yearly budgets and being aware of short-term spending capacity.

To calculate your working capital, gather your current assets and liability from your balance sheet and use the formula:

Working capital = current assets – current liabilities

Your working capital should cover your short-term bills and financial obligations. If not, you will need to make some major adjustments or look for external capital to ensure the survival of your business.

Current ratio uses the same data as working capital but provides a ratio to determine short-term financial health.

Current ratio can be calculated with the formula:

Current ratio = current assets ÷ current liabilities

A current ratio that is less than 1 means you may be unable to pay off financial obligations if they were to all be called in in a short time-period. A good current ratio is between 1.2 and 2.  A high current ratio is considered a positive for a company. Banks are more likely to extend credit to companies who can demonstrate that they have the ability to pay obligations. If a current ratio is super high, it might show that the company is not using its assets appropriately.

Using liquidity metrics is a great way to get an immediate snapshot of your current financial health. It should be checked often to make sure negative trends or negative liquidity doesn’t go unnoticed.

Financial Leverage Metrics

Leverage metrics tell you if your company is in a position to borrow from lenders or creditors. But before we learn what metrics to look out for, it’s important to know what leverage is and how it impacts your business.

Leverage means you have an increased earning potential with borrowed funds. Business owners often use leverage when they expect to earn more from borrowed funds by an amount that exceeds the cost of borrowing. A smart use of leverage can maximize the profitability of certain investments.

A key thing to note with leverage is that it amplifies losses as well. If your business does not perform the way you expect it to, then you’ll be paying off interest from your credit or loan with the money you need for more urgent issues caused by bad performance.

Metrics such as total debt to assets ratio can give you a good indicator of your leverage potential.

Total debt to assets ratio tells potential lenders if your company can pay off its loan in case the business fails. Basically, it measures the degree of leverage of the company.

Total debt to assets ratio can be calculated by the formula:

Total debt to assets ratio = (short-term debt + long-term debt) ÷ total assets

Total debt to equity ratio shows your company’s financial structure and is similar to total debt to assets ratio except it deals with your ability to pay off long-term financial obligations.  This is a common ratio in looking at a firms solvency.

Total debt to equity ratio = total liabilities ÷ total shareholder equity

The optimal debt to equity ratio varies by industry.

Profitability Metrics

Profitability metrics measure your business’ ability to earn. By understanding profitability, you can determine if your company is on track and has growth potential, or if action plans need to be put into place.

Gross profits + margins indicate if your business is producing and selling products efficiently. These metrics show earning ability before your overhead expenses are factored in. Gross profit margin and net profit margins are a good way to single out your product and see if it’s on track.

Profits give you a dollar amount of the amount made during the income statement period, while margins give you results as a percentage.

Gross profits = net sales revenues – cost of goods sold

Gross profit margins = gross profit ÷ net sales revenues

Operating profit + margins indicate earnings from your normal business operations. These metrics provide a snapshot of your profitability with all costs factored in.

Operating profit = gross profit – operating expense

Operating profit margins = operating profit ÷ net sales revenues

Operating profit includes depreciation and amortization, but does not include interest or taxes.

Growth Metrics

Growth metrics determine if your company is falling behind or is in a good position for future financial success. It’s vital to recognize what defines business success for your company, and what growth you should track.

Common indicators for growth include sales revenue, profits, working capital, and your customer base.

A simple way to calculate the growth rate for the previous year can be found in the following formula, but it works for any period.

2022 Revenue – 2021 Revenue = Yearly difference in revenue

Growth Rate = Yearly Difference in Revenue ÷ 2021 Revenue

A business with stagnant sales and profits can’t keep up with inflation. It’s vital to make sure your company is growing in the key metrics listed in this article, so you don’t fall behind.

Learn More About Financial Metrics with Signature Analytics

Understanding how to use business metrics can make businesses aware of problems as soon as they happen and plan proactively for the future.

Contact us today to learn more about Financial Metrics and how outsourced accounting can help you use your financial metrics to positively transform your business.

Internal Controls That Protect Your Business From Fraud

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News headlines involving embezzlement, fraud, data breaches, and other scandals may have you nervous, especially during the current economic climate. “What is happening within my organization?” might be a thought regularly occurring in your head. After all, fraud is one of the most common ways that companies lose money.

To protect your business from fraud, you must continually evaluate internal controls. These protocols help keep a business safe from specific types of company risk.

Incorporating internal controls can ensure the effectiveness and efficiency of operations and support reliable reporting.

Read More: This Is How To Protect Your Company From Employee Fraud

These Internal Controls Can Protect Your Company

According to the Association of Certified Fraud Examiners (ACFE), organizations can reduce the impact of fraud by pursuing internal controls and policies that actively detect fraud. Some examples may include management review, account reconciliation, and surveillance/monitoring.

Here are four other simple and straightforward internal controls for your company to consider:

1. ACH Payments
Do you have a custom signature stamp for your office? If you do, we advise against this option. Even if you keep it locked up or only allowed specific employees to use it, there are still issues with this kind of system.

A better option is to implement an electronic system such as Automated Clearing House (ACH) payments. By sending payments through ACH, businesses can use fewer resources than traditional paper checks, and they can more easily track income and expenses with electronic records.

eGuide: What Business Should Expect From Their Accounting Department

2. Separation of Powers
Separation of powers is as crucial to your business as it is to the government. When one person has all the power, the system is likely to fail. Just like a system of checks and balances, having dual control in place is ideal for any business.

One employee can be responsible for setting up ACH payments and wire transfers, while another employee can be responsible for approving these numbers.

Reviewing and catching critical errors is a vital part of this process. If there is oversight by more than one person, the possibility of theft and fraud significantly decreases. When dual control is in place, the system can often be effective in combating asset misappropriation.

By practicing the separation of powers, three main functions are able to occur:

1. Custody of assets
2. Authorized use of assets
3. Record keeping of these assets

It might seem that having two employees dedicated to managing assets is overkill for your small business. While it might be challenging to achieve, it should be implemented whenever possible to improve the overall performance of the organization.

3. Single User/Password
Every day you and your employees access websites to conduct business as usual. Many companies share one login to their bank, accounting software, credit card, and other financial accounts. Where do you store your vital login information? In a spreadsheet? On your phone? Printed out and next to your computer?

Either way, these are not secure ways to save your password information. These logins are so easy to hack and steal that it is up to your company to protect itself.

Make sure each user/employee is set up as an authorized user, and you can set the rights for each person. You can also research inexpensive and secure apps or websites to hold your logins, ensuring that the hacking rate drops significantly. When people leave the organization, make sure to delete the username and change common passwords.

4. Expense Reimbursement
Implement a process for all employees to follow regardless of hierarchy. Make sure to have an annually updated policy and require receipts/invoices over a certain dollar amount.

If you have corporate credit cards, you can utilize merchant category codes to restrict the types of goods/services for which they are used. For more information on this process, you can reach out to your card company for assistance.

Read More: The Three Main Internal Controls for Accounting and How They Protect Your Assets

How Should Internal Controls Be Implemented?

Has your business ever completed an internal control audit? If not, this is a great place to start. By completing an audit, the effectiveness of any current controls is tested, and the audit can also highlight weak points for the company.

When your organization takes part in an audit, there are essential processes and paperwork that need to be reviewed by a CPA. Having a set of eyes outside of your organization can be vital to the success of this audit.

While it might require preparation and a lot of documentation, the result will provide your organization with information that is consolidated all in one place, making it easy to access financial reports and statements in the future.

The implementation process itself can be quite an undertaking for a company to manage itself. For this reason, we recommend you find an expert to take on and manage this audit.

eGuide: What Business Should Expect From Their Accounting Department

How Often Should Internal Controls Be Updated?

All of your company’s internal controls should be updated yearly. One easy way to remember to do this is to make it part of your annual shareholder meeting where the control details can be documented and voted on.

While these are examples of simple internal controls to implement, the Signature Analytics team of experts can make recommendations based on your industry and the nuances of your business.

If you need assistance, please contact us to have internal controls set in place or feel free to ask us any other accounting and finance questions.

 

 

Discover how outsourced accounting can provide more visibility into your business

Top 10 Things Every Business Needs to Know About Sales Tax

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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.

Read more: Top 10 IRS Tax Issues

3. What rate do I charge my customers?

The state or other governing municipality determines the rate.

For example, California’s sales tax varies depending on the district. It can range from as little as 7.25% (the statewide minimum) to as much as 10.5% in the Los Angeles County suburb of Santa Fe Springs.

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.

  1. 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.
  2. 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.

Read more: How To Reduce Your Tax Liability

This Is The Bottom Line

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.

Tips And Tricks For Filing 1099s: The Deadline Is In January

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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.

What Are Examples Of The 1099 Form?

  • If you paid more than $600 to a freelance website designer, you must file Form 1099-MISC
  • 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.

Read More: Tax Planning Strategies: What You Need To Know For 2020

Get Started On The Forms Today

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.

 

 

Cryptocurrency: how electronic money can affect accounting

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Before we had paper money, developed countries like the U.S., Canada, Japan, etc. used commodity money; finite goods with intrinsic value like gold, salt, and cocoa beans, as mediums of exchange.

Even today, developing countries use commodity money as currency.

In 2005, a brewery in Cameroon promoted the sale of their beer by placing prizes under bottle caps. Winners could walk away with prizes ranging from a free bottle of beer to luxury cars. And because winning bottle caps were valued as much as $1 each, bottle caps were being used as a form of currency in place of money.

So what makes currency money?

Money doesn’t need to have intrinsic value to be considered valuable; it only needs to facilitate exchange.

What is cryptocurrency?

Cryptocurrency (Bitcoin, Litecoin, Ripple, etc.) is an electronic medium of exchange which typically utilizes blockchain technology. Cryptocurrency is not a “fiat currency,” meaning that unlike paper money issued by developed governments, cryptocurrency hasn’t been declared a legal tender.

What is the cryptocurrency impact on accounting?

When trying to account for cryptocurrency, one of the biggest issues is trying to recognize the true value of the asset. Accountants try hard to portray a company’s assets and liabilities as accurately and truthfully as possible, but when an asset’s inherent value fluctuates wildly and is not backed by something more concrete, such as a physical asset, it becomes difficult to definitively say “one unit of this cryptocurrency is worth X.”  

However, because cryptocurrencies are still a medium of exchange, the accounting treatment of an asset remains fairly constant over time.

Downsides of cryptocurrency

In 2009, North Korea informed citizens that the won (its national currency) would be redenominated. Not only was their currency changing, almost overnight, but citizens were only allowed to exchange a limited amount of old currency, rendering many people’s life savings worthless.

Government-issued currencies have an inherent protection of the value by the backing organization’s credit (in the case of the U.S. dollar, the Federal government guarantees the value). Unfortunately, without being a government-backed coin, cryptocurrency has the potential of being just as volatile. Volatility typically arises from the fact that there is no underlying asset from which the cryptocurrency derives its value.

How businesses can leverage cryptocurrency

There are plenty of risk-averse companies performing services in exchange for cryptocurrency or similar related obligations (i.e. call options, warrants, etc). This obviously depends on your risk appetite and ability to withstand a negative outcome from the investment.

Depending on the cash needs of the business and the speculative volatility of the cryptocurrency, it may be an alternative means of fundraising, even if supplemental to the typical means of currency such as bank loans, angel investors, or private equity.

Another option is to undertake what is called an Initial Coin Offering, or ICO. This is similar to an IPO (Initial Public Offering) whereby a company has a set amount of cryptocurrency coins they sell to the public in order to raise capital. Although the concept is still relatively new and the regulatory bodies are grappling with how to treat ICOs, popularity will increase over time particularly because they aren’t usually tied to specific assets. Instead, they are akin to corporate paper in that they are backed only by the reputation of the issuing entity but are not a debt instrument.  

Cryptocurrency has the potential to make a lot of money from fluctuations. Accountants should know how to help their clients understand the tax ramifications of electronic money or how it can affect reporting. If your business needs assistance with reporting, accepting cryptocurrency for payment, or leveraging cryptocurrency, contact us today.

Leading vs. Lagging Metrics

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Metrics are an important tool to measure results and drive the right behaviors in a business. The best businesses utilize metrics to improve results and involve staff at all levels in the reporting of these results. However, one mistake that business owners often make is looking only at lagging metrics. In order for metrics to be useful in driving performance results, the business needs to look at leading metrics. The earlier the business can catch issues and problems, the better off the business will be, as it’s easier and less expensive to solve issues earlier rather than later.

For tangible examples, here are two often-used metrics that are often used to measure results that are detrimental to a business. By taking a closer look at the inputs to these metrics, the business owner can see which behaviors and processes are influential and measure them separately, so as to drive better results.

Scrap/Yield

Scrap and yield losses are critical business metrics to measure. However, once the business reaches the point of scrapping a product, the loss has already occurred. The business owner needs to go upstream and measure behaviors that drive better yield and scrap results. For example, a business owner could measure vendor quality at receiving/inspection. Metrics such as PPM (parts per million, or defect rates from the vendor) effectively show whether the parts that are received from the vendor meet the desired quality specifications. If quality can be measured at the vendor level, then there is a higher chance that the final product yields will be higher and scrap will be lower.

Employee Turnover/Retention

Voluntary turnover is an important measure for HR. But by the time the business reaches the point of measuring turnover, the employee has already gone. By measuring certain behaviors, the business owner can identify issues before a good employee leaves the company. One problem might stem from reviews and raises not being delivered on time. If HR begins measuring the delivery of reviews each month, with the goal set at 100% on-time reviews. This could make employees feel more valued by the company and lead to a reduction in employee turnover.

When used effectively, business metrics are an invaluable tool to measure a company’s results and drive the right behavior and actions among employees. But a business owner shouldn’t only look at the metrics used to measure the business. He or she should also question whether the metric is a leading or lagging indicator, and consider the flow of data for that metric. The more outcomes the business owner can measure upstream, the easier it is to find and correct problems and issues before they become unfavorable results.

Employee Stock Option Basics: Considerations & Best Practices

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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.

Could Your Company Benefit from Setting Up A DISC?

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If you are in the export business, you may have heard of an interest charge domestic international sales corporation, otherwise called an IC-DISC. If this is your first time hearing about it, there is a lot of information to cover. Let’s get started!

First and foremost, an IC-DISC is one way an export company can reduce their taxable income. Your company (aka the exporter) can pay the commission of the IC-DISC (owned by shareholders or partners). These commissions are then deductible by your company for federal tax reasons, and the IC-DISC is an exempt entity. Pretty cool right?

If your company has taken advantage of this kind of strategy in the past, it’s crucial to understand the nuances of the IC-DISC and how tax law can impact your business for the next tax season.

What Is An Interest Charge Domestic International Sales Corporation?

An IC-DISC is an export tax incentive that offers federal income tax savings to U.S. domestic businesses that export U.S. made goods. The tax incentive was created in 1971 by Congress to promote the increase of exports by allowing companies to defer income and have interest charged on the deferred tax. Shareholders of a DISC receive reduced income tax rates on qualifying income from exports of U.S. made goods.

Under IC-DISC, income related to export sales can be taxed at a lower capital gains rate of 20% — much lower than the rate for flow-through entities (39.6%) and C corporations (35%).

What Are The Requirements For An IC-DISC?

You might be wondering if setting up an IC-DISC is right for your business. There are many benefits to setting up this type of strategy, but your business must qualify and therefore follow the IC-DISC rules. The export sales must meet these stipulations, according to Eide Bailly:

  1. The export property must be manufactured in the US
  2. The export property must be sold for direct use outside the US
  3. 50% or less of the sales price must be attributed to imported materials

Generally, an IC-DISC is not taxed on its income. However, the shareholders of the IC-DISC are taxed when the income is distributed. According to the IRS, to qualify as an IC-DISC, a domestic corporation must meet the following terms:

  • Have a minimum of 95% of its gross receipts (within the given tax year) qualify as exports
  • Export assets must be at least 95% of the sum of the adjusted basis of all its assets
  • Have only one class of stock, and any outstanding stock should come to at least $2,500 every day of the new tax year
    • New corporations
  • Not a member of a controlled group where a member is a foreign sales corporation (FSC).
  • Elect to be treated as an IC-DISC for the tax year
  • Maintain separate records and books

Companies may benefit from reviewing the IC-DISC benefit before filing taxes. Many business owners are not aware of the IC-DISC tax incentive and end up missing out.

Several different types of corporations may qualify for IC-DISC status and the associated DISC tax benefits. Specifically, the law states that if a domestic company meets all the following criteria, it’s eligible to apply for Domestic International Sales Corporation status:

Here are a few examples of companies that may be eligible for IC-DISC elections:

  • If it exports 95% of its goods
    • A “good” is a broad term that can refer to several different items – such as agricultural products, technology, or art
  • It provides architectural or engineering services conducted in the U.S. for building a structure outside of the U.S.
    • Example: Company A is based in Austin, Texas, and designs a bridge built in Brazil
  • It manufactures a product that goes into another product that is exported outside of the U.S.
    • Example: Company A manufactures rubber for shoes that are shipped to New Zealand

How To Set Up A Domestic International Sales Corporation

Once approved, a separate corporation is formed with the DISC status. This corporation will not have:

  • any activities other than what is on paper
  • any activities unrelated to the export of U.S. goods

The DISC will maintain a contract with the first corporation (the “Supplier”) that produces or resells the U.S. made goods for export for services in exchange for a fee. The fee is deductible by the Supplier, which reduces its federal income tax. The fee will result in a net profit recognized by the DISC; however, because of its status, it’s not subject to federal income tax. Therefore, any profits from the DISC are distributed to its shareholders as a dividend. For this reason, it only incurs taxes at the rate applied to dividends, which are currently significantly less than the federal income tax level.

What Are The Potential Tax Savings Of A DISC?

One of the most intriguing aspects of this strategy is the calculation of commission paid expense to the IC-DISC by the company who owns it.

There are a few simplified methods used to calculate the commission:

  1. 4% of gross export receipts
  2. 50% of combined taxable income from export sales

To better explain the tax savings these entities may be eligible for, here’s an example:

A corporation has $40 million in gross export receipts and $15 million in net export income on such sales. If the owners have established a DISC entity, the greater of 4% of gross receipts ($1.6 million) or 50% of net export income ($7.5 million) may be paid as commissions to the DISC. This $7.5 million of commissions will reduce taxable income of the corporation and may be able to be distributed to the shareholders of the DISC as dividends.

Assuming a federal income tax rate of 39.6%, the corporation will reduce its tax bill by $2.97 million. If the individual dividend tax rate were 15%, then the individual owners of the DISC who receive the dividend of $7.5 million will be required to pay taxes of $1.13 million. This results in net savings by the owners of $1.84 million.

When Is It Time To File A DISC?

Mark your calendars! A corporation must file Form 1120-IC-DISC by the 15th day of the 9th month after the tax year ends, and according to the IRS, no extensions are allowed. The IC-DISC tax returns are filed with the Covington Kentucky Service Center.

Up until a recent IRS audit, corporations could mail in their DISC paperwork: however, the IRS found numerous recurring errors on the documentation. The IRS now audits IC-DISCs, making sure that companies provided the proper documentation for the IC-DISC. According to the IRS, to properly prepare the IC-DISC return, all schedules and forms must be returned in the following order:

  • Schedule N (Form 1120)
  • Form 4136
  • Schedule D (Form 1120)
  • Form 8992
  • Form 8993
  • Additional schedules in alphabetical order
  • Additional forms in numerical order

To read more on how to file your IC-DISC correctly, read the IRS instructions for Form 1120-IC-DISC.

Read More: Resolution to organize your finances and grow your business

What Should You Do Next?

Think your corporation may be eligible to file for DISC status? Discuss it with your accounting department, outsourced accounting team, or tax provider and get their feedback. Signature Analytics is also available to discuss the DISC status of your business, as well as any accounting support or financial analysis needs you may have.

Read More: Outsourced CFO Services

Signature Analytics does not provide tax services, but we can act as the accounting and finance department on our clients’ behalf. This allows us to regularly work with tax providers on identifying strategies for minimizing a corporation’s tax bill.

Contact us today to learn more or to schedule a free consultation.



Preparing for an Annual Audit or Review: How to Eliminate the Pain and Reduce Overage Fees

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If your company is looking for financing from investors or financial institutions, considering a potential acquisition, or foresees an IPO within the next three years, you may need to have an annual financial statement review or audit.

Many dread the infamous annual audit for several reasons:

  1. It demands a significant amount of time for preparation,
  2. Management must field exasperating questions from auditors, prepare numerous schedules and gather supporting documentation, and
  3. Costs can become astronomical.

What Information Will You Need to Provide the Auditors?

To begin, the audit firm will provide management with a list of anywhere from 50 to 150 initial requests that can include items, such as:

  • Articles of incorporation and bylaws and any subsequent amendments
  • Board minutes from inception
  • Fluctuation analysis’ on balance sheet and income statement accounts
  • Reconciliations and support for reconciling items
  • All debt and equity agreements
  • Fixed asset additions and disposals

Once these initial items are provided to the auditors, they will typically request additional supporting documentation, which can include:

  • Bank statements
  • Check copies
  • Invoices
  • Bills
  • Payroll reports
  • Supporting schedules for any accrual or estimate balances

How Long Will the Annual Audit Process Take?

Depending on your preparedness, the organization of your accounting department, your bandwidth to take on the additional hours required to assist the auditors, and the cleanliness of your financial information, an audit can last anywhere from 3 weeks to a full year.

The Cost of Not Being Prepared

Before getting started, the audit firm will provide you with a schedule and budgeted fee that assumes the team can complete the audit with minimal issues; however, if the company is not appropriately prepared, there will likely be significant delays. Any additional time it takes to provide adequate schedules and support in excess of the time that was originally budgeted will impact the auditors’ initial schedule. This can result in a lack of availability for the audit team, preventing them from completing the audit and providing an opinion on time.

If you’re not prepared, the result will be obvious in the audit firm’s final bill, which can include thousands of dollars in overage fees.

Eliminate the Pain and Overage Fees from the Annual Audit Process

If your company is not appropriately prepared, the annual audit process can be an expensive undertaking, both in employee time and company money. It does not have to be though! By enlisting the right assistance, it is possible for your audit to be a simple, stress-free, and a less expensive process.

Hiring an outsourced accounting firm, such as Signature Analytics, that provides you with a professional team of accountants and certified public accountants (CPAs) who have previously been auditors themselves, can significantly reduce the amount of re-work for a company because they know exactly what schedules and support the auditors are looking for.

An outsourced accounting team can prepare schedules in advance so the auditors do not waste unnecessary time waiting for the schedules to be completed. They will also assist with handling inquiries and follow-up questions that arise during the audit process, reducing, if not eliminating, overage fees.

Ultimately though, one of the most valuable tools an outsourced accounting team can bring to the annual audit process, is freeing up your internal staff to focus on their daily responsibilities with minimal interruption due to auditor requests.

Be Prepared for Your Next Annual Audit or Financial Statement Review

Whether you are preparing for your first annual audit, or are dreading an upcoming audit because you have incurred significant overages and delays in the past, Signature Analytics can help. We will ensure that your company is fully prepared and that your financial and business records are in order, making the annual audit process as painless and efficient as possible. We will be the main point of contact for the auditor during the entire process so your staff can focus on their day-to-day responsibilities.

Contact us today to learn how we can help reduce your annual audit fees and minimize the disruption to your business during the process.

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