Managing inventory productively

From Wikimedia Commons

One of the most challenging aspects of running a business is managing inventory in a productive way.

First of all, what is inventory?  These are the products that you have purchased which you plan to resell to customers.

One new-wave approach to inventory management is “made-to-order.”  This means that you produce products when customers order them.  A great example of this is Lulu or CreateSpace, which will manufacture books as your customers order them.

Another approach is to sell products that can be costlessly produced.  For example, many web entrepreneurs sell PDF files of books. These files can be produced and made available for download an infinite number of times at no cost.

But not every product can be made to order or costlessly produced.  Many inventory products must be produced in quantity before they are ready for sale.  Suppose you run a farm.  Before you can sell a vegetable, you must plant a seed, grow it, harvest it, and get it to market.  Other products must be manufactured in bulk, perhaps in the Far East.

The trick here is to produce and stock the right amount of inventory, not too much and not too little.  Stocking too much inventory absorbs your cash flow (and can lead to high interest expense), requires storage costs, and creates risk of spoilage or obsolescence.  Stocking too little inventory may cause you to run out of product that your customers want, hurting your sales.

What makes this even trickier is that you must stock the right quantity of inventory of every single item you sell. The farmer needs to sow, grow, harvest, and get to market the right number of tomatoes, cabbage heads, squash, and everything else.  Too much of any specific item? It will spoil, unsold.  Too little? Lost sales.

To monitor how productively you’re managing inventory, keep an eye on inventory turnover ratio or number of day’s inventory. This financial statement ratio can signal whether your inventory levels are too high or low.

 

New blog: Freaking Important

I’m experimenting with a new blog, which I called Freaking Important.  This is a productivity blog.

The title come from Stephen M. Covey, who says that we should focus on the “important” things, and not just the “urgent.”

Anyway, I’m using the blog to clean out my backlog on the ol’ to-do list. I had 125 items on Sunday.  As of today, I’m down to 54. Anyway, check the blog out for great productivity tips, and especially tips on using OmniFocus for iPad.

 

Assets explained

An asset is something that:

  • you have paid for and
  • you expect to benefit from in the future.

Cash is an asset.  So is merchandise held for sale.  So is a receivable, money owed to you by a customer.  Larger assets can include a car that you own or real estate.  Even a software program or website design that you paid for can be an asset.

Critical to the idea of an asset is that you expect to benefit from it in the future.  If something loses its value (for example, your merchandise becomes spoiled), then the benefit will disappear and it is no longer an asset.  It becomes an expense.

When you are trying to decide whether to buy a new asset (such as one of those slick MacBooks), consider how it will increase revenue and profits for your business.  If it won’t increase revenue and profit, then don’t buy it.

Business-wise, we like assets because they produce revenue and profits.

Tax-wise, we are not so crazy about assets because you usually can’t deduct them immediately.

 

3 Simple rules for managing your cash flow

I have three rules for managing cash flow:

  1. Collect sales as early as possible.
  2. Pay bills as late as possible.
  3. Plan carefully.
Rule 1: Collect sales as early as possible.
E-commerce companies typically collect payment before providiing services.  For example, online subscriptions typically collect payment before the customer can access the product.  As long as your customers are willing to go along with it, this is a great thing.

It is also a common strategy in the online world to give things away for free.  But such freebies usually cost nothing to reproduce (e-books, etc.).  Do not risk giving away costly products before you get paid for them.  And (even more importantly) don’t risk not getting paid for services and products that cost you money.

Rule 2: Pay bills as late as possible.
When you buy goods and services, suppliers will often permit you to pay your bills 30 or even 60 days after you receive the goods.  Take advantage of these policies.  Pay these bills on the last date possible before they become overdue – not sooner, not later.  A consistent history of on-time payments will help build positive relationships with your suppliers.
Rule 3: Plan carefully
Plan your future cash flows two or three months into the future.  Create a spreadsheet with the following columns:

Date | Description | Increase (Decrease) | Balance

Then list the cash flows that you realistically expect to come in and go out over the next few months.
Watch the “balance” column – if it goes negative, then you need an additional positive cash flow to avoid an overdraft.

Over here, I posted a simple Google Docs Spreadsheet Template to plan cash flows, and a video explaining how to use it.

[Image: Day 4 – Paying off debt by quaziefoto, on Flickr]

If you find this post helpful, please let me know in the comment box below.

 

How much is your self-employment tax?

H23 BB00934850 * ...my $100 'star note'Self-employment tax can eat up a huge chunk of your income (up to 13.3%). 

Here is how to calculate self-employment tax for a self-employed individual operating as a sole proprietorship.
The two components of self-employment tax are social security tax and medicare tax:
In 2012, Social security tax is 10.4% of the first $106,800 in your business’ net income. If you earned wages or tips (aside from your self-employment income), then you pay social security tax only on the first $106,800 of your combined wages, tips, and business net income.
Medicare tax is 2.9% of all of your business’ income.
A few simple examples to illustrate:
Joe earned $60,000 in net income from his business, and nothing else.  This is subject to Social security tax (10.4%) and Medicare tax (2.9%).
$60,000 x (10.4% + 2.9%) = $7,980
Mary earned $150,000 in wages and $60,000 from her business.  The employee’s share of social security tax will be deducted from her paycheck, meeting the $106,800 maximum.  The $60,000 earned from her business will be subject only to Medicare tax (2.9%).
$60,000 x 2.9% = $1,740

Pat earned $75,000 in wages and $60,000 from their business.  The employee’s share of social security tax will again be deducted from her $75,000 paycheck.  Because the $106,800 maximum has not been met, then the remaining business income, up to the maximum ($106,800 – 75,000) is subject to both Social security tax and Medicare tax.  Business income exceeding $106,800 will be subject only to Medicare tax.
$106,800 – $75,000 = $31,800 subject to both Social security & Medicare
$31,800 x (10.4% + 2.9%) = $4,229.
$60,000 – $31,800 = $28,200 subject only to Medicare
$28,200 x 2.9% = $818
$4,229 + $818 = $5,047.
Self-employment tax is regressive: the more money you make, the lower the rate you pay.  If you have no additional job, then you will pay the highest rate of taxes on your self-employment income ($7,980, or 13.3%) whereas if you have a well-paying $150,000/year job, then you will pay the lowest rate of taxes on your self-employment income (just $1,740, or 2.9%).
As if this isn’t sufficiently complicated, 50% of your self-employment tax is deductible for purposes of figuring your Adjusted Net Income (but not as a business expense).
Legislation alert: If a bill to renew the current rate reduction is not passed, then Social security will pop back up to 12.4% on January 1, 2013, for a combined rate self-employment tax rate of 15.3%.  This 2% tax increase will also hit employees’ wages.
Be careful to plan for self-employment tax when computing your estimated taxes.
More information on the IRS’ website.
[Image: H23 BB00934850 * …my $100 ‘star note’ by TheAlieness GiselaGiardino²³, on Flickr]
 

Most new businesses fail

HENRY'S GROCERYUnfortunately, most new businesses fail. Inevitably, the product isn’t quite what the customer is looking for, or the price is too low to make a profit, or the price is too high, or supplies are limited, or an ex runs away with the cash box, or the rent becomes unaffordable, a competitor learns how to do whatever you do cheaper and faster, or the Feds take you down.  Chances are more likely than not that, when someone starts a business, someone or something is going to come along and end it all.  That’s life.

This is why some new businesses could be so extraordinarily profitable.  There is risk in starting a new business – great risk – and with that risk will come reward for the lucky few who succeed (ex. Mark Zuckerberg).  For every Mark Zuckerberg or Bill Gates, there are thousands, perhaps even hundreds of thousands of entrepreneurs who failed.

So how do you manage?

First, accept from the outset that statistics show that you will probably fail.  I’m sure you’re special but the statistics say that you will probably fail anyway.  Sorry.

Now take the challenge head on.  Think about what could go wrong, and then proactively address it.

  • Customers might not like your product.  Now address the risk:  Make sure that your product has a customer base.
  • Your ex might run away with your cash box.  Now address it:  Lock your cash away in a safe place.
  • You are concerned that your product is illegal.  Now address it: Get legal help.

Consider all of the risks and then address them as best you can.  The earlier that you identify and address problems, the more likely you will be able to successfully manage them.

Furthermore, don’t take unnecessary risks.  Don’t invest more time or money in your business than you have to.  Don’t buy five computers if you only need one and don’t buy expensive high speed computers if a basic model will do the trick.  The statistics show that for every minute and every penny that you spend working on your business, you will not reap any profits.  So don’t spent more time or money on your business than you have to.  Here’s the test: “If I fail, (and I probably will fail) will I regret investing in this?  Will I regret spending time on it?”  If the answer to either question is yes, then spend your time and money elsewhere.

So then, if you’re probably going to fail, and you shouldn’t take any unnecessary risks, then why bother starting a business?

Do it for it’s own sake.  Do it because it’s fun, it’s educational, and it’s exciting.  Do it because you enjoy it.  Invest money because you want to – you want to see if you can do it.  Take risks because you want to see what happens.  Invest yourself into the task so that, whatever the outcome, whether you turn out rich or poor, you can say that you enjoyed the ride.

It’s like going to Las Vegas.  The odds are stacked against you – you will probably lose – so why bother?  Because the games are darned fun to play, that’s why.

And if you fail (as you probably will)?  Then don’t quit.  Learn from your experience and try again.

[Image: HENRY’S GROCERY by striatic, on Flickr]

 

Deducting interest on your home mortgage

John Brown's Farmhouse
John Brown’s Farmhouse
by Tony the Misfit, on Flickr

Interest on your home mortgage is deductible from your taxes if you file Schedule A (i.e. you itemize deductions).  The mortgage must be secured by your home or your second home.

Mortgage interest paid to individuals (such as a relative) are also tax deductible.

Home equity loans (“second mortgages”) taken for home improvements are also usually tax deductible.  However, home equity loans taken to pay other expenses (such as buying a car) are subject to limitations.

Most points paid on mortgages are also tax deductible.

The rules here get quite complicated.  Here they are.

Oh, and by the way, tax deductible or not, never take out a loan that you won’t be able to pay back.

 

What are audited financial statements and why?

boy, with homework

Working on an A+

Suppose that your child got to write their own report card. At the end of the semester, the child figures out their grades, writes them down, and then mails them to their parents.  How would the parent know that the grades were free of bias or error?

Such is the issue with financial statements.  Reported directly by managers, financial statements provide a “report card” of managers’ performance.  Corporate managers prepare their own report cards.  How can you, the investor, be assured that those financial statements are free of bias or error?

Enter the independent auditor.  The independent auditor goes through the books and issues a statement (called the auditor letter) that they were prepared in accordance with GAAP, generally accepted accounting principles, that they were properly prepared and can be relied upon by investors.

In the US, Independent auditors are firms of CPA’s, Certified Public Accountants, who are specifically licensed to conduct audits.  The largest CPA firms are called the “Big Four:” Deloitte, Ernst & Young, KPMG, and PricewaterhouseCoopers.  Many other CPA firms are qualified to conduct audits, and similar audits are typically conducted all over the world.  This is an international system.

Audits must be prepared in accordance with Generally Accepted Auditing Standards.  Public companies (those traded on a stock exchange) in the US must also comply with the “Sarbanes-Oxley Act” and the PCAOB, the Public Companies Accounting Oversight Board.

Who audits the auditors?  The auditors use a system of professional review, where different audit firms check each others’ work.  Auditors are also subject to review by the PCAOB.  They are legally responsible for their audits.

This system of independent audits is controversial.  Scandals like at Enron and WorldCom have plagued the accounting profession, and may have been caused by fundamental flaws in the audit system.  Auditors rely on statistical probabilities, so that they do not check and double-check every single transaction.  This means that, in any independent audit, there is a small probability of failure, i.e. that the financial statements are not accurate and cannot be relied upon.

[Image: boy, with homework by woodleywonderworks, on Flickr]

 

Be an accountant

winnie 014 accountant kitty is not amusedIt’s not difficult to become an accountant.

In my 15 years as an accounting professor, I’ve had the good fortune to help prepare thousands students for the accounting profession.  Many of them probably never considered accounting until they started to study it.

Careers in accounting provide tremendous job satisfaction, high salaries, and comfortable job security.  Opportunities abound in public accounting firms, private companies, government, and even not-for-profit organizations.  While Bob Cratchit might be the stereotypical accountant, in reality accountants go places, advance, and meet people.  While they must know how to “crunch numbers,” they must also know how to work with others.

This is not going to sound politically correct, but key here is to earn the CPA designation.  In most states, this can be accomplished by:

  • completing 150 hours of course work usually with a bachelor’s degree plus additional college credits.
  • passing the CPA exam, and
  • completing an experience requirement.

Each state has its own requirements. Here is a list of state boards of accountancy.  Keep in mind that many states offer reciprocity – you can become certified in one state, and then recognized in another.  Therefore, you can get licensed in a state other than the one where you live.

What if you already have a college degree and you started a different career, but are thinking of switching to accounting?  Do you need to start all over?

Absolutely not.  Most states will let you take the CPA exam and get certified with a Masters of Science degree, which can often be completed in less than two years, part-time.  Many states will even let you take a simple series of courses to qualify to take the exam.  Furthermore, Masters of Science programs will offer recruiting opportunities and help you set up interviews for your first job.  The most rigorous programs are usually accredited by the AACSB in Accounting.  (BTW, in case you’re in the New York/New Jersey area, here is our program.)

In summary, if you’re looking for a satisfying, secure, and well-paying position, and you want to get started within two years, accounting may be the right field for you.

[Image: winnie 014 accountant kitty is not amused by apium, on Flickr]