November 2003
By JAMES S. ANCHIN, CPA
With the beginning of the new year just around the corner, there are important strategies that should be considered for the company's year-end financial statement presentation and tax planning. It's critical to make sure these two areas are considered hand-in-hand, so that smart tax planning won't unnecessarily hurt your financial statement presentation.
In the area of financial statement presentation, contractors should aim to put their best financial foot forward for sureties and banks. The single best way to impress them is to show a profit. But whether profitable or not, there are certain strategies companies can implement to present themselves in a more positive light. In today's tough bonding and financing arena, understanding the best ways to present your financial statements to sureties and bankers is critical. Working capital, current assets less current liabilities, is a key element in determining bonding capacity or the ability to obtain financing. Banks and sureties often make adjustments to working capital to arrive at an "adjusted working capital." The more you anticipate these adjustments and plan accordingly, the stronger your bonding capacity and credit line will be.
A company's balance sheet presents a snapshot of financial position as of a point in time. At year-end, it may make sense to maximize your cash, even if it means deferring some accounts payable until after the first of the new year. Cash is the first line on the company's balance sheet and showing a healthy cash balance creates a positive impression (however, if your company is on the cash basis of accounting for income tax purposes, it may make more sense to pay down payables and show a lower cash balance).
Thoroughly evaluate your past due accounts receivable to determine whether they should be written off, reserved against or are still collectible. A direct write-off is deductible for tax purposes, whereas reserves generally are not. In either event, past due receivables over 90 or 120 days old are generally excluded by sureties when calculating adjusted working capital.
Prior to year-end, make sure you are as up to date as possible in billings for contracts in progress. The aim is two-fold: the sooner you bill the sooner you can get paid. In addition, you will reduce the amount of underbillings shown on your year-end balance sheet.
Significant underbillings make banks and sureties nervous. They often perceive them as overstated profits or hidden losses. If your project managers have billed to the maximum by year-end and you still have underbillings, management should investigate the situation. This type of review is valuable on several fronts in that it typically speeds up cash flow and pinpoints problem jobs or contracts that should be negotiated on a different basis in the future.
Prepaid expenses present another planning opportunity. Prepaid expenses such as deposit premiums on insurance policies are generally excluded by sureties in calculating adjusted working capital. Structure policy periods to the extent possible to minimize the amount prepaid at year-end. Structure annual maintenance contracts to minimize the amount prepaid at year-end. For example: pay the deposit for a February 2004 trade show on Jan. 1, 2004 as opposed to Dec. 31, 2003.
Sometimes contractors may use excess cash to pay for purchases instead of financing those purchases over a long-term period. While this may make economic sense, replacing a current asset (cash) with a long-term one will reduce working capital and can hurt bonding capacity. It is beneficial to finance the equipment over a three to five-year period. However, if working capital was used to finance equipment or other big-ticket purchases during the course of the year, long-term borrowing against these assets prior to Dec. 31 will enable the company to boost its working capital position at year-end.
The timing of equipment purchases is also key, especially in light of recent tax law changes. Up to 50 percent of the cost of qualifying equipment can be expensed for income tax purposes in the year of acquisition. This should be considered in determining whether a piece of equipment should be purchased in December 2003 or January 2004.
When it comes to year-end tax planning, a key issue is understanding what accounting method your company uses for income tax purposes. While the percentage of completion method is generally the standard for financial reporting purposes, there are a number of different methods for income tax purposes, depending upon a company's size. Understanding what method you utilize will impact decisions you make prior to year-end. As discussed earlier, a decision that makes sense for tax purposes may not make sense for financial reporting purposes.
The impact of the alternative minimum tax (AMT) method must also be considered when doing year-end tax planning. AMT is an alternative way of calculating taxes whereby certain adjustments are made to regular taxable income to arrive at alternative minimum taxable income. The most common adjustments for contractors pertains to the accounting for long-term contracts and depreciation of fixed assets. Tax is calculated under both methods and the taxpayer pays the higher amount. Failing to consider the impact of AMT can lead to unpleasant surprises on April 15. While AMT may not always be avoidable, it can be anticipated and its impact minimized with proper planning.
Year-end tax planning strategies and financial statements are both key to a company's continued success. Used as complementary tools, they have the potential to maximize a contractor's financial health and their ability to do business going forward. Your accountant should be working with you to make sure you are optimally positioned for year-end.
About the author: Mr. Anchin is a managing partner of Anchin, Block & Anchin, LLP, a regional certified public accounting firm with offices in New York City and Westchester, that specializes in meeting the needs of contractors in the tri-state area.