Credit Reports: What You Should Know
How do lenders determine who is approved for a credit card, mortgage, or car loan? Why are some individuals flooded with credit card offers while others get turned down routinely? Because creditors keep their evaluation standards secret, it is difficult to know just how to improve your credit rating. It is important, however, to understand the factors and to review your credit report periodically for any irregularities, omissions, or errors. Reviewing your credit report annually can help you protect your credit rating from fraud and ensure its accuracy.
Credit Evaluation Factors
Many factors determine your credit. Here are some of the major factors considered:
- Age
- Residence
- “Authorized user” payment history
- Checking and savings accounts
- Bankruptcy
- Charge-offs (Forgiven debt)
- Child support
- Closed accounts and inactive accounts
- Jobs
- Payment history
- Recent loans
- Collection accounts and charge-offs
- Cosigning an account
- Credit limits
- Credit reports
- Debt/income ratios
- Department store accounts
- Payment history/late payments
- Finance company credit cards
- Income/income per dependent
- Mortgages
- Revolving credit
- Name/alias
- Number of credit accounts
- Fraud
- Inquiries
These factors may be used, and weighted, in determining credit decisions. Credit reports contain much of this information.
Obtaining Your Credit Reports
Credit reports are records of consumers’ bill-paying habits. They are collected, stored, and sold by credit bureaus.
Credit reports are also called credit records, credit files, and credit histories. Under federal law, you are allowed access to free credit reports. There are three major credit bureaus and thousands of smaller ones where you can obtain a credit report.
These credit bureaus offer free credit reports, as well as monthly credit reports and services for a fee.
- Experian Credit Bureau: 888-397-3742 (cost: free or $14.95 monthly)
- Equifax Credit Bureau: 800-685-1111
- Trans Union: 877-322-8228 (cost: $11.95 monthly)
If you have been denied credit, you can request that the credit bureau involved provide you with a free copy of your credit report – but you must request it promptly. Otherwise each of the bureaus will provide you a copy of the report for a fee. You can request a copy from their websites (see links above) or toll-free numbers (also listed above).
Disputing Errors in Your Credit File
The Fair Credit Reporting Act (FCRA) protects consumers in the case of inaccurate or incomplete information in credit files. The FCRA requires credit bureaus to investigate and correct any errors in your file.
Tip: If you find any incorrect or incomplete information in your file, write to the credit bureau and ask them to investigate the information. Under the FCRA, they have about thirty days to contact the creditor and find out whether the information is correct. If not, it will be deleted.
Be aware that credit bureaus are not obligated to include all of your credit accounts in your report. If, for example, the credit union that holds your credit card account is not a paying subscriber of the credit bureau, the bureau is not obligated to add that reference to your file. Some may do so, however, for a small fee.
Fair Credit Reporting Act (FCRA)
This federal law was passed in 1970 to give consumers easier access to, and more information about, their credit files. The FCRA gives you the right to find out the information in your credit file, to dispute information you believe inaccurate or incomplete, and to find out who has seen your credit report in the past six months.
Understanding Your Credit Report
Credit reports contain symbols and codes that are abstract to the average consumer. Every credit bureau report also includes a key that explains each code. Some of these keys decipher the information, but others just cause more confusion.
Read your report carefully, making a note of anything you do not understand. The credit bureau is required by law to provide trained personnel to explain it to you. If accounts are identified by code number, or if there is a creditor listed on the report that you do not recognize, ask the credit bureau to supply you with the name and location of the creditor so you can ascertain if you do indeed hold an account with that creditor.
If the report includes accounts that you do not believe are yours, it is extremely important to find out why they are listed on your report. It is possible they are the accounts of a relative or someone with a name similar to yours. Less likely, but more importantly, someone may have used your credit information to apply for credit in your name. This type of fraud can cause a great deal of damage to your credit report, so investigate the unknown account as thoroughly as possible.
We recommend an annual review of your credit report. It is vital that you understand every piece of information on your credit report so that you can identify possible errors or omissions.
If you have any questions about how to obtain your credit report or how to interpret what’s in your report, contact me.
Reads From Last Week
I am back on the racks over at Alltop. Thank you everyone for helping get there.
What is it?
Alltop is sort of a “digital magazine rack of the Internet. To be clear, Alltop sites are starting points” the site provides categorized selections of links to blogs and other web resources that make it easy to scan a lot of information on a particular subject. For example the Taxes page lists many tax blogs with links to the most recent posts. Alltop is a valuable resource for anyone wanting to research, or just keep up on, well, stuff. If you have ever been to a real magazine rack you know.
Anyway, I am very excited to have been added once again. Very Exciting times. . .
THE REPORT ON TAX REFORM OPTIONS – In a meeting yesterday afternoon (Friday, August 27th) the President’s Economic Recovery Advisory Board (PERAB) released its report, summarized their concerns, and voted to send the report to President Obama for review.
Paul Volcker has the President’s ear on tax reform…but will he listen?
Obama tax reform panel report released
10 Year Treasury Bond at Lows.. What Does it Mean?
Another great source of collected blogs BlogRoll Beans from Cafétax
Let the Charitable Mud-Slinging Begin!
The Internet is the Best, and Worst, Thing That Happened to Tax Planning and Preparation – the Internet has a long memory – as in, forever. So, things posted in 2004 might have been true then, but no longer are true. But that doesn’t stop search engines from pulling old articles and others from posting the articles on their website in an attempt to boost Google search rankings.
My favorite news this week, What You Can Learn From Roni Deutch’s $34 Million Fraud Lawsuit.
Read more about Roni Deutch’s $34,000,000 Lawsuit:
Brown Seeks $34 Million from TV’s Tax Lady Roni Deutch: Official News Release
TV Tax Lady Roni Deutch Facing Legal Troubles
Tax Lady Roni Deutch Sued for “Heartless Scam”
Roni Deutch Sued by California AG
‘Tax Lady’ Accused of Unladylike Behavior
Unladylike Behavior or Election Year Politics?
California Sues Roni Deutch for “Heartless” Pennies on the Dollar Tax Scheme
Here’s what she had to say, Tax Lady: California lawsuit ‘election year politics’
The TaxProf has more.
The Internet, Virtual Meetings, and Taxation
Tax Relief for Innocent Spouses – You Must Act Swiftly to File Your Claim with the IRS – In recent tax relief news, the Seventh Circuit Court of Appeals ruled that the IRS can continue to apply the two-year deadline for taxpayers looking to file for “innocent spouse” relief. Basically, this treasury ruling upholds that taxpayers claiming innocent spouse tax relief must make their claims within 2 years of the IRS’s commencement of collection action.
What is meant by an “innocent spouse”?
Tax and the City: Philly Tax Takes on a Life of Its Own
A Tax on Blog Writing or on Blog Business?
Philadelphia Demands License Fee and Taxes from Bloggers
All in all, I’d rather not be in Philadelphia
Click here for more information on Alltop. Or go to their home page at Alltop.com to start checking out your favorite information.
Tax Tips for Students with a Summer Job
Are you a student with a summer job? Here are eight things you should know about the income you earn during the summer months.
- All taxpayers fill out a W-4 when starting a new job. This form is used by employers to determine the amount of tax that will be withheld from your paycheck. Taxpayers with multiple summer jobs will want to make sure all their employers are withholding an adequate amount of taxes to cover their total income tax liability. To make sure your withholding is correct, contact my office.
- Whether you are working as a waiter or a camp counselor, you may receive tips as part of your summer income. All tip income you receive is taxable and is therefore subject to federal income tax.
- Many students do odd jobs over the summer to make extra cash. If this is your situation, keep in mind that earnings you receive from self-employment are subject to income tax. This includes income from odd jobs like baby-sitting and lawn mowing.
- If you have net earnings of $400 or more from self-employment, you also have to pay self-employment tax. (Church employee income of $108.28 or more must also pay.) This tax pays for your benefits under the Social Security system. Social Security and Medicare benefits are available to individuals who are self-employed just as they are to wage earners who have Social Security tax and Medicare tax withheld from their wages. The self-employment tax is figured on Form 1040, Schedule SE.
- Subsistence allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay – such as pay received during summer advanced camp – is taxable.
- Special rules apply to services you perform as a newspaper carrier or distributor. You are a direct seller and treated as self-employed for federal tax purposes if you meet the following conditions:
- You are in the business of delivering newspapers.
- All your pay for these services directly relates to sales rather than to the number of hours worked.
- You perform the delivery services under a written contract which states that you will not be treated as an employee for federal tax purposes.
- Generally, newspaper carriers or distributors under age 18 are not subject to self-employment tax.
- Income you receive for certain types of work may be considered self-employment income and thus, potentially subject to self-employment taxes. For example, income received from odd jobs such as babysitting and lawn mowing may be considered self-employment income. If your net income from self employment is $400 or more you will be subject to self-employment tax.
A summer work schedule is sometimes a patchwork of odd jobs – which makes for confusion come tax time.
Tax Benefits for Job Seekers
Some people- especially these days – are polishing their resumes and attending career fairs in search of employment. If you are searching for a job this summer, you may be able to deduct some of those expenses on your tax return.
Here are six things you need to know about deducting costs related to your job search.
- To deduct job search costs, the expenses must be spent on a job search in your current occupation. You may not deduct expenses related to looking for a job in a new occupation.
- You can deduct employment and outplacement agency fees you pay while looking for a job in your present occupation. If your employer pays you back in a later year for employment agency fees, you must include the amount you receive in your gross income up to the amount of your tax benefit in the earlier year.
- You can deduct amounts you spend for preparing and mailing copies of a resume to prospective employers as long as you are looking for a new job in your present occupation.
- If you travel to an area to look for a new job in your present occupation, you may be able to deduct travel expenses to and from the area. You can only deduct the travel expenses if the trip is primarily to look for a new job. The amount of time you spend on personal activity compared to the time spent looking for work is important in determining whether the trip is primarily personal or is related to your job search. (If you have questions about how to figure this, call us.)
- You cannot deduct job search expenses if there was a substantial break between the end of your last job and the time you begin looking for a new one.
- You cannot deduct job search expenses if you are looking for a job for the first time.
Where to Learn About Job Openings
- Personal contacts
- School career planning and placement offices
- Employers
- Classified ads:
- National and local newspapers
- Professional journals
- Trade magazines
- Internet resources
- Professional associations
- Labor unions
- State employment service offices
- Federal Government
- Community agencies
- Private employment agencies and career consultants
- Internships
Here are some job-seeking goals:
- 3 prospects per-day
- 4 phone calls each morning
- 10 resumes sent out each week
- 4 informational interviews per-week
- 3 interviews per-month
Reads from Last week
Yes This post is on top on purpose Don’t Let the Naysayers Get You Down.
From The Wondering Tax Pros WHAT’S THE BUZZ? TELL ME WHAT’S A HAPPENNIN’ I found “How Will Healthcare Reform Affect MY Taxes?” I would agree with my blogging friend here that it seems to do a good job of answering the question. And seriously if you aren’t reading his twice a week post What’s the Buzz, you missing a lot of great info.
Working from Home: Do You Have a Back-Up Plan? – One of the great things about working from home, and running your own business, is that you have a great deal of flexibility. Your dress code is flexible. Your schedule is largely flexible. The types of jobs you take can be flexible. However, there are some issues that you can run into when you work from home, and these are not so flexible.
This has to be my personal favorite this week.
Education and Wealth: You Don’t Need a College Degree, But You Need an Education – College is overrated. There, I said something you’ve probably suspected since you were in high school and may have confirmed several years after you entered the workforce. You probably know many people who excelled in college and can barely string together a cohesive thought. And you probably know many successful people who never went to college, barely made it through college, or work in a field unrelated to their degree.
THE COST OF TAX RETURN PREPARER REGISTRATION From THWTP is a statement. As I have read it, Robert is pointing out clearly, how little this is going to cost when figured out from a realistic perspective. Yes my friend, as in your practice this will only cost less than $1.00 per client or “set” as you put it. For me in my math I was just over a dollar and I have chosen not to even bother raising prices based on these new Regs. and expenses. I am sure the whole world of Tax preparation is aware (preparers) the cost are minimal. Unfortunately, most in our world will take advantage of the situation. They’ll monopolize on the idea that their cost have gone up and thus must raise their cost to their clients. What I am saying is I agree that the cost is very low per client, but money hungry tax preparers, CPA, Tax Attorneys and the others, I see them raising pricing, beyond their cost.
Shulman Power Grab To Be Paid for by $64.25 Charge Per Practitioner
IRS Announces New Return Preparer Application System and User Fee
The IRS released (IR-2010-91) the new proposed regulations amending Circular 230
“The IRS and the Treasury Department estimate that the total annual costs resulting from these requirements will be $9,880,000 for all affected practitioners and $38,632,500 for all affected continuing education providers.
Estimated total annual record-keeping and reporting burden is 1,710,000 hours
Section 10.3(f) of the proposed regulations establishes a new “registered tax return preparer” designation. A registered tax return preparer is any individual so designated under §10.4(c) who is not currently under suspension or disbarment from practice before the IRS. An individual who is a registered tax return preparer pursuant to this part is a practitioner authorized to practice before the IRS, subject to the limitations identified in these proposed regulations.”
WSJ: Give Away Money to Charity, Not to Foundations
IRS to Audit 6,000 Businesses at Random and Take Back What It’s Owed in Unpaid Employment Taxes – Earlier this year, the Internal Revenue Service began employment tax audits of approximately 6,000 U.S. companies to provide statistical data for the National Research Program study of employment tax compliance.
(Take the lesson.)
Can the Consumer Financial Protection Bureau save us from ourselves?
Please Explain To Me… – What unique internal procedures does a CPA firm that other tax firms don’t have? I really want to know too.
Results are In: You STILL Hate the IRS!
So you hate the IRS? Well, you’re not the only one. Near the end of last week an Internal Revenue Service Office was evacuated after a suspicious envelope arrived.
3 Tips to Maintain Focus on Your Financial Goals
Your 2011 tax burden revised – Late last month Kay Bell reported on the Tax Foundation’s online calculator that will let you compare your 2011 federal income tax liabilities under three possible tax collection scenarios. Not a group to just sit and wait, the Foundation’s numbers crunchers have updated the interactive calculator to include the Democrats’ plan for the expiring Bush-era tax cuts. Read more. . .
Prepare for the crash tax – The taxing possibilities from jurisdictions scrambling for every possible dollar just keep coming.
How to Best Utilize Health Savings Accounts – 2010 and 2011 HSA Limits and Tax Rules
Investor or Business Owner? The Right Structure Makes a HUGE Difference
The IRS’s Dirty Little Trick on Real Estate Investors – Material Participation Rules
Court: Internet Church Is Not a ‘Church’ for Tax Purposes
The U.S. Court of Appeals for the Federal Circuit on Monday ruled that the Foundation of Human Understanding, a 47 year old § 501(c)(3) nonprofit church that conducts weekly Internet and radio services, is not a church for § 170 purposes. Foundation of Human Understanding v. United States, No. 2009-5129 (Fed. Cir. Aug. 16, 2010):
Tax Politics and Economic Uncertainty
“According to Martin Regalia, chief economist of the U.S. Chamber of Commerce, “Uncertainty is the probably the biggest factor retarding economic growth.” He made this comment at an economic summit, at which, according to this report, other participants called for cuts in government spending, reduction of the federal budget deficit, a reduction in government regulation of business, and reform of the tax system, though Regalia, according to another report, also supports extension of the Bush tax cuts.”
What is Stop Loss Pay? Stop loss pay is compensation being paid to those members of the military service who were not allowed to leave the service on time. This pay is on top of all other pay provided to the soldiers. It is specific compensation for not being able to leave the service. How to Claim Stop Loss Pay for Military Personnel
The government is paying $500 for every month that a soldier was stop lossed.
If the average stop loss length of time is 6 months that’s $3,000 due to every single one of those soldiers (on average). That’s a significant amount of money in my eyes. Enough money to propel your savings goals forward. Enough money to fund 60% of an IRA this year.
4 Ways to Maximize Your Stop Loss Pay – The government is giving a specific set of soldiers, on average, $3,000 in stop loss pay. Hopefully these men and women of our armed forces have a plan for a couple thousand dollars falling in their laps. If not, then read this post.
My two post from last week The Pulse of Your Business, and Planning Retirement Withdrawals kind of stayed from the tax info, but the information is good information for those who it was written for. Both these post are from my August Newsletter. If you’d like to sign up to receive this kind of information you can do so from the Newsletter page. For those of you who like there is an RSS link as well.
Do you want to not worry about money all the time? Or do you ever wish that you were never in debt? Here are 5 great ways to save money fast! 5 Easy Tips to Save Money.
I wish I had wrote this. Car Finance How to Decide on Whether to Lease Or Buy a New Car I have a lot of clients that would need to use this information.
Business Car Leasing The Most Economical and Smart Thing to Go For
Refinancing Myth: Looking Beyond the Monthly Payment and Calculating the True Cost of Your Refinance – Mortgage lenders often attract homeowners seeking to lower their mortgage interest rate with some simple math, usually presented in one of two ways:
1) Comparing the nominal closing costs to the total savings from 30 years of a lower monthly payment, or
2) How few months it will take before you break even with your refinancing closing costs due to lowering the monthly payment
Either way, the refinance looks very attractive: for a little cash up front, you can save far more money over the term of the loan. But don’t be fooled by the numbers – a lower monthly payment does not always mean saving more money, and it has little to do with the closing costs. The paradox can be explained easily by calculating the true total cost refinancing the loan.. . .
From L & R Tax Prep Web site refinance calculator
Other useful Calculators
Rent vs. Buy
Should you rent or should you buy your home? It takes more than looking at your mortgage payment to answer this question. This calculator helps you weed through the fees, taxes, and monthly payments to help you make a good financial decision.Mortgage Qualifier
The first step in buying a house is determining your budget. This interactive problem solver steps you through the process of finding out how much you can borrow.Mortgage Refinance Analyzer
Should you refinance your mortgage? Find out how much money you’ll save and how long it will take to breakeven on a mortgage refinance?Mortgage Reduction Analyzer
Save thousands of dollars in interest by increasing your monthly payment. Find out how much sooner you will pay off your mortgage by making extra payments?Mortgage Comparison: 15 years vs. 30 years
Determining which mortgage term is right for you can be a challenge. Use this calculator to compare these two mortgage terms, and let us help you decide which term better for you.Mortgage Points Evaluator
Should you pay points? This calculator helps you determine if you should pay for points, or use the money to increase your down payment.
Waking up sick Friday morning was just bad timing. I had a lot of things to do, where people depended on me. The work got done, but in part, no thanks to me. Saturday wasn’t much better. I was able to at least get some work done yesterday; it wasn’t near as much as I would have hoped.
In Closing this long list, I would like to point out that I have added some new links to my Blog rolls.
Angell EYE is an application development company that has been providing custom integration and web services for over 5 years. We deliver web site design and development, custom web application development and advanced web programming, FileMaker development, and more.
Over the past 5 years, Angell EYE has been specializing in custom eBay integration and PayPal Payments Pro solutions. 1 of only 12 PayPal Certified Ace Developers, we have had the pleasure of integrating PayPal for numerous happy clients. L & R client also
The Best Credit Card Processing System For Your Business. Unleash The Power of PayPal & Turn Your Laptop or Desktop PC Into a Fully Functional Credit Card Processing System! Credit Card Processing for Fixed Locations or Wireless Freedom,
Accept Major Credit Cards with one low FLAT RATE – L & R client also
a non-profit that connects organizations involved with aging research, facilitate the exchange of information, provide publications and bring people together to understand why aging research is requiring their full attention.- L & R client also
The Top 10 Highest State Income Taxes: All Obama Blue States
Forbes, States (And Bill Gates Sr.) Look to Soak the Rich, by Ashlea Ebeling:
- Hawaii: 11% (income over $400,000 (couple), $200,000 (single))
- Oregon: 11% (income over $500,000 (couple), $250,000 (single))
- California: 10.55% (income over $1 million)
- Rhode Island: 9.9% (income over $373,650)
- Iowa: 8.98% (income over $64,261)
- New Jersey 8.97% (income over $500,000)
- New York: 8.97% (income over $500,000)
- Vermont: 8.95% (income over $373,650)
- Maine: 8.5% (income over $39,549 (couple), $19,749 (single))
- Washington, D.C.: 8.5% (income over $40,000)
Planning Retirement Withdrawals
Are you thinking of retiring soon, or changing jobs? You may face a major financial decision: what to do about the funds in your retirement plan. This article will discuss partial withdrawals and full withdrawals.
Note: As you will see, the rules on retirement withdrawals are quite complex. They are offered here only for your general understanding. Please call us before taking withdrawals or making other major changes in your retirement plan.
Take a Partial Withdrawal
Partial withdrawals are withdrawals that aren’t rollovers, annuities, or lump sums. Because they are partial, the amount not withdrawn continues its tax shelter (see below).
A partial withdrawal will usually leave open the option for other types of withdrawal (annuity, lump sum, rollover) of the balance left in the plan.
Note: Before retirement, partial withdrawals are fairly common with profit-sharing plans, 401(k)s, and stock bonus plans. After retirement, they are fairly common in all types of plans (though least common with defined-benefit pension plans).
Tax Planning. A partial withdrawal is taxable (and can be subject to the penalty tax on withdrawals before age 59-1/2) except to the extent it consists of after-tax contributions, such as nondeductible IRA contributions.
Example: Your retirement account totals $100,000, which includes an after-tax investment of $10,000. You withdraw $5,000. $500 of the withdrawal is tax-free ($10,000 / $100,000 x $5,000).
Note: The tax-free portion is computed differently for plan participants who have been in the plan since 5/5/86. Contact us for details.
Preserving the Tax Shelter. Your funds grow sheltered from tax while they are in the retirement plan. This means that the longer you can prolong the distribution – or the smaller the amount you must withdraw – the more your assets grow. Some people choose to defer withdrawals for as long as the law allows to maximize assets and shelter them for the next generation.
Note: The law has specific rules about how fast the money must be taken out of the plan after your death. These rules limit the ability to prolong a tax shelter.
Withdrawal Before You Reach Age 70-1/2
Until you reach 70-1/2, you do not need to take money out of your retirement account – unless your employer’s plan requires it. In fact, there will usually be a 10% early-withdrawal penalty if you make withdrawals before age 59 1/2. This is on top of the regular income tax you owe – at any age – on amounts you withdraw (though there’s no tax on after-tax contributions you made, as we discussed above).
Once You Reach Age 70-1/2
Once you hit 70-1/2, withdrawals must begin. Technically they can be postponed until April 1 of the year following the year you reach 70-1/2 – say April 1, 2011 if you reach 70-1/2 in 2010. But waiting until April 1 means you must withdraw for two years – 2010 and 2011 – in 2011. To avoid this income bunching and a possible higher marginal tax rate, we may suggest withdrawing in the year you reach 70-1/2. Call us to evaluate your situation.
The rules allow you to spread your withdrawals over a period substantially longer than your life expectancy. Under these rules, the taxpayer (say, an IRA owner) first determines how much he’s saved as of the end of the preceding year. Then he consults a (unisex) IRS table to find the number for his age. The number corresponds to how long he may spread out the withdrawals. The owner then divides that number into the retirement asset total. The result is the minimum amount he must withdraw for the year.
Example: Joe reaches age 70-1/2 in October of this year. Retirement plan assets in his IRA totaled $600,000 at the end of last year. The IRS number for age 70 is 27.4. Joe must withdraw $21,898 ($600,000/27.4) this year.
Example: Two years from now, Joe is 72 and his IRA was $602,000 at the end of the preceding year (when Joe reached age 71). The IRS number for age 72 is 25.6. Joe must withdraw $23,516 ($602,000/25.6) when he’s 72.
The number in the IRS table assumes distribution over a period based on your life expectancy, plus that of a beneficiary 10 years younger than you. If your designated beneficiary is a spouse more than 10 years younger than you, his or her actual life expectancy is used to figure the withdrawal period during your lifetime.
Caution: You can always take out money faster than required – and pay tax on these withdrawals. However, the tax code is strict about minimum withdrawals. If you fail to take out what’s required, a tax penalty will take 50% of what should have been withdrawn but wasn’t.
Financial Calculator: L & R Tax preparation Calculators – Click Retirement then Required Minimum Distribution The IRS requires that you withdraw at least a minimum amount – known as a Required Minimum Distribution – from your retirement accounts annually, starting the year you turn age 70-1/2. Determining how much you are required to withdraw is an important issue in retirement planning.
Contact me if you’d like assistance figuring out proper withdrawal amounts. Getting those numbers right can make a big difference in the quality of your retirement.
The Pulse of Your Business
Unfortunately, many small business owners do not fully understand their cash flow statement. This is shocking, given that all businesses essentially run on cash, and cash flow is the lifeblood of your business.
Some business experts even say that a healthy cash flow is more important than your business’s ability to deliver its goods and services! That’s hard to swallow, but consider this: if you fail to satisfy a customer and lose that customer’s business, you can always work harder to please the next customer. But if you fail to have enough cash to pay your suppliers, creditors, or employees, you’re out of business!
What Is Cash Flow?
Cash flow, simply defined, is the movement of money in and out of your business; these movements are called inflow and outflow. Inflows for your business primarily come from the sale of goods or services to your customers. The inflow only occurs when you make a cash sale or collect on receivables, however. Remember, it is the cash that counts! Other examples of cash inflows are borrowed funds, income derived from sales of assets, and investment income from interest.
Outflows for your business are generally the result of paying expenses. Examples of cash outflows include paying employee wages, purchasing inventory or raw materials, purchasing fixed assets, operating costs, paying back loans, and paying taxes.
Note: An accountant is the best person to help you learn how your cash flow statement works.
Cash Flow Versus Profit
Profit and cash flow are two entirely different concepts, each with entirely different results. The concept of profit is somewhat broad and only looks at income and expenses over a certain period, say a fiscal quarter. Profit is a useful figure for calculating your taxes and reporting to the IRS.
Cash flow, on the other hand, is a more dynamic tool focusing on the day-to-day operations of a business owner. It is concerned with the movement of money in and out of a business. But more important, it is concerned with the times at which the movement of the money takes place.
Theoretically, even profitable companies can go bankrupt. It would take a lot of negligence and total disregard for cash flow, but it is possible. Consider how the difference between profit and cash flow relate to your business.
Example: If your retail business bought a $1,000 item and turned around to sell it for $2,000, then you have made a $1,000 profit. But what if the buyer of the item is slow to pay his or her bill, and six months pass before you collect on the account? Your retail business may still show a profit, but what about the bills it has to pay during that six-month period? You may not have the cash to pay the bills despite the profits you earned on the sale. Furthermore, this cash flow gap may cause you to miss other profit opportunities, damage your credit rating, and force you to take out loans and create debt. If this mistake is repeated enough times, you may go bankrupt.
Analyzing Your Cash Flow
The sooner you learn how to manage your cash flow, the better your chances for survival. Furthermore, you will be able to protect your company’s short-term reputation as well as position it for long-term success.
The first step toward taking control of your company’s cash flow is to analyze the components that affect the timing of your cash inflows and outflows. A thorough analysis of these components will reveal problem areas that lead to cash flow gaps in your business. Narrowing, or even closing, these gaps is the key to cash flow management.
Some of the more important components to examine are:
- Accounts receivable. Accounts receivable represent sales that have not yet been collected in the form of cash. An accounts receivable is created when you sell something to a customer in return for his or her promise to pay at a later date. The longer it takes for your customers to pay on their accounts, the more negative the effect on your cash flow.
- Credit terms. Credit terms are the time limits you set for your customers’ promise to pay for their purchases. Credit terms affect the timing of your cash inflows. A simple way to improve cash flow is to get customers to pay their bills more quickly.
- Credit policy. A credit policy is the blueprint you use when deciding to extend credit to a customer. The correct credit policy – neither too strict nor too generous – is crucial for a healthy cash flow.
- Inventory. Inventory describes the extra merchandise or supplies your business keeps on hand to meet the demands of customers. An excessive amount of inventory hurts your cash flow by using up money that could be used for other cash outflows. Too many business owners buy inventory based on hopes and dreams instead of what they can realistically sell. Keep your inventory as low as possible.
- Accounts payable and cash flow. Accounts payable are amounts you owe to your suppliers that are payable some time in the near future – “near” meaning 30 to 90 days. Without payables and trade credit, you’d have to pay for all goods and services at the time you purchase them. For optimum cash flow management, examine your payables schedule.
Some cash flow gaps are created intentionally. For example, a business may purchase extra inventory to take advantage of quantity discounts, accelerate cash outflows to take advantage of significant trade discounts, or spend extra cash to expand its line of business.
For other businesses, cash flow gaps are unavoidable. Take, for example, a company that experiences seasonal fluctuations in its line of business. This business may normally have cash flow gaps during its slow season and then later fill the gaps with cash surpluses from the peak part of its season. Cash flow gaps are often filled by external financing sources. Revolving lines of credit, bank loans, and trade credit are just a few of the external financing options available that you may want to discuss with us.
Monitoring and managing your cash flow is important for the vitality of your business. The first signs of financial woe appear in your cash flow statement, giving you time to recognize a forthcoming problem and plan a strategy to deal with it. Furthermore, with periodic cash flow analysis, you can head off those unpleasant financial glitches by recognizing which aspects of your business have the potential to cause cash flow gaps.
Prepare your taxes on-line With L & R Tax Preparation
L & R Tax Preparation
Tax Preparation, Payroll, and Accounting,
Including online services.
E=MC2 or use QuickBooks
