Small Business Taxes & ManagementTM--Copyright 2020, A/N Group, Inc.
The good news is businesses are opening up; the bad news is not all of them, and many not to the same extent as before the crisis. Until an effective vaccine is available it's unlikely to be business as usual. Some businesses may be able to return to regular activities with very little, if any, modifications. But restaurants, retail stores, etc. are likely to be limited to 25 or 50 percent of capacity and may have other restrictions.
The first is, what will the state allow? New York has been strict; some other states not so much. But even many places that are opening are doing so with restrictions. Construction and manufacturing is allowed--bars and tatoo parlors still aren't. Determine how quickly your state will open.
The second is, will the customers come back? Even if restaurants could be filled to capacity, will customers come? There's going to be reluctance on the part of more than a few customers. While it may feel like we've had 75 percent of the population come down with COVID-19, a very large portion has not been infected. A significant portion of those individuals will probably still be wary of catching the virus, at least for some time.
Third, will they have the money to spend? This one is actually a two parter. The individual who was laid off and just recently rehired could be using funds to make back mortgage payments, take care of deferred maintenance on the house or car, etc. and won't have extra cash for discretionary items. Some workers may not be hired back immediately when the business reopens, or might not be rehired at all. Business owners are likely to be running a tight ship having lost several months' of revenue. The second part is, even if an individual has the money, will they spend it? When you've just recovered from having to ask for a forbearance on your mortgage, rent, or electric bill, you might try to rebuild your savings account rather than spend $100 or a dinner for two. The depression in the 30's permanently changed the spending habits of a generation.
One thing is certain, running a small business is going to be even more challenging than usual in the next couple of years.
Where do you go from here?
The first step to making decisions is to understand the problems and do an analysis of your situation moving forward. The initial shock is over and by now you should have a better idea of where you and your business stand. We'll list the steps you should take, but not in detail. If you've got savvy in the areas listed you can go it on your own, but this is not the time to do so if you're not qualified. Get professional advice. Your business may depend on it.
Break-Even Analysis For many businesses this is an important starting point, particularly in the current environment. The theory is that some costs are fixed, such as rent, the remainder are variable. (Go to Break-Even Analysis for a complete discussion of this analysis.) This analysis is important because there's a good chance your revenue may not recover to the pre-COVID-19 levels, at least not for a while. You may have no real fixed expenses and work out of your house and don't have employees, but many businesses are more complicated. Can your restaurant survive if you can only operate at 50 percent of capacity? The answer for most restaurants is probably not very well; for some not at all. But a specialty retailer that has an online presence and has very high margins may not feel much of an impact. Keep in mind that some variable costs are "lumpy". Once you open the restaurant you'll need a cook and a waiter, even if you only get one customer an hour.
In any sort of analysis where the current and/or future numbers are far from certain, take the time to do a sensitivity analysis. In other words, play with the numbers to see what happens. Even a simple spreadsheet model will allow you to do some what ifs.
If you've got to get your volume well above the capacity of your business under COVID-19 restrictions, you might want to consider a plan before before continuing. That could include reducing costs (e.g. rent renegotiation) or coming up with another option for increasing sales and/or margins.
Sales Projections That's essential. How difficult it will be to make any sales projections will depend on your business. Restricted by state rules? Dependent on area businesses that might be restricted? (E.g., an unrestricted business near an amusement park.) Dependent on discretionary spending? There's not much guidance out there. The good news is that, in general, things are not as gloomy as a couple of weeks ago. The best advice here is, if you're even slightly insecure about the future, start with your best estimate and factor in several more negative forecasts.
Cost Projections These should be easier. Some costs may be lower--your staffing expenses should be less if you've got less employees. Some will be higher. You may have to hire another employee to disinfect regularly. You may have to put up partitions. If you have employees working from home, you may be able to reduce your rent expense. Will you need price cuts or extra advertising to lure customers back?
Cash Flow Projections This is the critical analysis. If you don't have enough cash flow to make payments on a bank loan, you've got a real problem. Cash flow isn't the same as net income, but you may be able to start with net income and back into cash flow. Things that increase cash flow include:
decrease in accounts receivables
increase in payables
sale of equipment
depreciation and amortization
increase in borrowings
capital contribution from shareholders
Items that decrease cash flow include:
increase in accounts receivable
decrease in payables
purchase of equipment
repayment of loans
distributions to shareholders
For example, Madison Inc. has net income for the quarter of $300,000. At the end of the quarter its receivables were $30,000 higher than at the end of the prior quarter. Payables went up by $24,000. Depreciation for the quarter was $15,000. Madison made a principal payment on its bank loan of $6,000. Madison's cash flow for the quarter would be:
Net Income $300,000
Increase in Receivables - 30,000
Increase in Payables 24,000
Loan Repayment - 6,000
Cash Flow 303,000
The increase in receivables uses cash because you didn't receive the money so income has to be reduced. Payables is almost the exact opposite. Depreciation increases cash flow because, while it's been deducted in calculating net income, there's no cash outlay. (The cash outlay was when you paid for the equipment some time ago.)
There are other items that affect cash flow, but these are the most commonly encountered ones in a small business. If you use an accounting program, cash flow for the current period is probably computed by the program. To project cash flow you may need some help. There are other ways to compute your cash flow, but this approach is the easiest to explain and work with. Doing a cash flow projection for a partnership or sole proprietorship may involve some different terms, but the approach is the same.
Without a cash flow projection you'll have no idea if you can make the payments on that bank loan, pay your suppliers, come up with the money for the new equipment on order, or, even if the business can survive. That's true whether you're affected by the COVID-19 pandemic or just in the usual course of business. The difference is when business is normal, many companies can just "wing" it. That may not work in this case, particularly if your business has to operate at less than capacity, incur new costs, has to cut prices or advertise more to recoup business, or if there's a recurrency of the virus.
Second Step--Actions to Take
You may have to make some difficult choices. If you're allowed to open, is business coming back? How quickly? If you were struggling before, you've got to take an objective look at where the business is going. The prospects for manufacturers will depend on the products. For retailers and restaurants much depends on their customer base. If most of your business is very loyal customers, you may recoup most of your sales. If you depend on passing highway traffic, things may be tougher. For many businesses you'll be in uncharted territory. Economists were all wrong on the unemployment projection for the end of May. One large retailer reported much stronger sales on reopening then they forecast. That's good news. But there's also a possibility that this is just a short-term bounce from pent-up demand. Once that demand has been met, revenue may drop to a lower level. And there's always the possibility the virus can flare up again in your markets. Unemployment projections by the Congressional Budget Office and the Federal Reserve are widely divergent. With such unpredictable forecasting, there are still steps you can take.
Stay Flexible That's one reason small businesses can succeed in almost any environment. Be prepared for a quick move in either direction. Be ready to capture a quick recovery and be ready to cut back quickly if demand drops. You may also see a change in customer preferences. For example, more online ordering instead of in store or restaurant customers. Pricing changes from suppliers may be reflected in customer demand.
Survival not Growth The first step is to make sure you can survive under the new conditions. Once that's achieved, look to growing the business.
Examine Product/Service Lines You may want to cut back or eliminate certain less profitable lines, particularly those with low volumes. A move that always makes sense.
Review Costs Operating costs could go up for many businesses--more space, initial decline in productivity, cost of special accommodations, etc. You may be able to offset some of those extra costs by having more employees work from home or by cutting expenses. Unless it's a survival question, be careful where you cut.
Renegotiate with Suppliers Often a supplier won't survive if you don't survive. (Well, you and other customers.) See what breaks you can negotiate, at least for the short term. Longer credit payment terms can help your cash flow. You may be able to renegotiate rental terms. Again, it depends on you position. An important tenant in the building has more of a chance.
Pricing There are two sides to this. You may have no pricing power and with competitors running sales you may have to follow. On the other hand, now could be the time to increase prices. Customers may realize there are additional costs incurred or be immune having seen some of the price jumps at the grocery store.
Owner Distributions We've heard many business owners say "I only take a $50,000 salary". Yes, but the business pays the lease on their personal car, they take associates out to dinner regularly, and they take distributions at various times during the year. If you analyze those expenses you may find a significant amount of cash leaving the business.
Analyze Cash Flow We explained the rudiments above. If times are tough, that cash flow projection will give you an idea of how long you can weather a drop in business (and/or increase in costs), if you can handle a potential second wave of the virus, etc.
Close or Financial Assistance? It's sad to say, but not all businesses will survive. Recognizing that is difficult. Business owners are generally optimistic. But cutting your losses can make sense. The cash flow projection will tell the story. Only you can decide how much you'll need and if you can fund the shortfall with loans or capital contributions. But if you've missed a bank payment, are getting third notices from suppliers, and haven't made the employment tax deposits this month, you have a serious problem. When looking at the business, don't forget to factor in the money--either in salary or distributions--you'll need to live on. If you're a consultant, salesmen, professional, etc., work out of the house and have no employees you may be able to hold out forever. That's not the case if you have employees, rent and suppliers to pay, etc.
If you decide to stick it out and need funds, can you acquire them at a reasonable price? If you have little or not debt (not counting trade debt) you might be able to secure funding. Banks may be careful considering the economic uncertainty. If you're a small business you'll almost assuredly have to guarantee the loan personally. If you don't pay, the lender can go after you personally.
Relatives can be a cheaper source of funds, but there are obvious relationship problems. That's even more true of friends. Consider some soul searching before going that route. Another option is taking on a partner. While there are obvious disadvantages, there are many pluses. He or she could help with the workload and add input. Having a partner can also make the business more attractive to suppliers and lenders.
Bankruptcy. The final option. Or is it? There are two types of bankruptcies. One is a liquidation. Basically, the assets are sold, the creditors are paid and the business is gone. In a reorganization the debts may be partially forgiven, but the business continues. In most cases the creditors receive stock in the company. That can happen if there's potential for the company to survive. Some states have a third option. You definitely need legal advice from a bankruptcy attorney if you're at this point. This is a specialized area of law.
Get Good Advice This is not the time to go it alone. Your CPA should be able to help, at least with the numbers. Chances are he or she can also advise on many other aspects of the business. Most have had experience with a number of businesses. In addition, he probably has a list of contacts who can help with areas they can't. It will cost, but it's cheap compared with the alternative. You may be able to get help from a local Chamber of Commerce, Small Business Administration, and other local sources. Whatever your approach, don't delay. Unless you can see tangible proof of a strong bounce in revenue, solving the issues will only get harder.
Copyright 2020 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject. Copyright is not claimed on material from U.S. Government sources.--ISSN 1089-1536
--Last Update 06/11/20