Accounting and Finance for Your Small Business Second Edition_11

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Accounting and Finance for Your Small Business Second Edition_11 Evaluating the Operations of the Business SECTION III entirely. In effect, the deferred taxes may be less when paid after the law changes instead of before. The rate, or the method of calculation of liability, could change. Of course, the reverse may also be true. • A tax deferral is, in effect, an interest-free loan from the federal government. It can be recognized as a valid financing source because there can be no more favorable rate than a zero inter- est rate for a loan. • Many tax options are under the company’s control. When one option fails to be favorable, it can change to another. Tax planning can have significant advantages. It can help con- serve cash flow by deferring the payment of taxes. It can make avail- able interest-free capital for the financing and purchase of new fixed assets or expansion. It can free up additional cash and make more disposable cash available for payout. Controlling Tax Liabilities When planning for treatment of tax expenses, consider these accounting methods and choices of accounting periods for control- ling the amount of tax liabilities that may be incurred. Deferred Installment Sales A company may be able to defer income if it makes sales of per- sonal property on an installment sales basis. An installment sale is defined for tax purposes as requiring two or more payments. Therefore, a company that sells personal property on a credit basis requiring only one payment in a certain period would not qualify for use of this deferral method. This deferral is permitted even if the overall method of accounting used is an accrual method. The com- pany realizes a cash flow improvement by not having to prepay the tax on profits until they have been realized in cash payments. If you sell on installment sales contracts, do not fail to utilize this deferral method. 232 Taxes and Risk Management CHAPTER 8 Another consideration is the company’s credit policy. In estab- lishing a credit policy, the firm should consider the tax advantages of certain installment sales. This deferral gets particularly beneficial if the company is experiencing an increase in accounts receivable. Typically, big-ticket-item retail stores, such as furniture and appli- ance dealers, can take significant advantage of installment sales deferment. By looking to the installment sales method of tax defer- ments, the company may not only have the benefit of deferring income taxes, but it may also provide an opportunity to charge slow-paying customers interest in consideration for extended pay- ment terms. Bad Debt Method One company may choose to recognize its bad debts for tax pur- poses at the point where these debts actually become known to be worthless. Another company may set up a reserve and obtain a tax deduction based on an estimate of the debts that will be bad. The reserve method simply accelerates the tax deduction for bad debt, because the deduction is allowed in the year the reserve is estab- lished, based on the probability of some accounts going bad, rather than when the specific debt is determined to be bad. Accounting for Inventory Sometimes, by changing accounting methods, a company can elim- inate short-term profits associated with inflation and the cost of inventory. In other words, if the company has significant inventory levels that were produced at lower costs and it is currently pro- ducing inventory at much higher expenses, by selling off the most recently made or purchased inventory items, the company will realize a profit only between the current selling price and the cur- rent higher costs. In doing so, the company retains, as a matter of bookkeeping, only old inventory at lower costs. This is a change from a first-in, first-out (FIFO) accounting system to a last-in, first- out (LIFO) system. 233 Evaluating the Operations of the Business SECTION III State Tax Considerations When locating offices and plants, a company with multistate oper- ations should take into consideration the states in which legislation has been passed giving lower taxes for business. Lower state taxes can substantially reduce tax liability and will not inhibit the busi- ness from engaging in interstate commerce. Another important consideration is whether the state has a tangible pe ...