Tuesday, September 15, 2009

Cash Under the Table vs. Business Value

A word of caution for those owners who fail to report "significant" amounts of cash and use these funds for personal uses. This may turn out to be, "penny wise and pound foolish."

While this industry relies to a large extent of charge sales and established accounts, there are occasions where business owners receive cash payments and yet fail to report these cash payments and just pocket the money instead.

Forgetting for a moment that such activities are considered "Tax Evasion" by the IRS and may subject you to criminal prosecution, there is also another negative to note as well - Withdrawing cash from the business impact the value of your business down the road by a factor of three ot five times what you have taken out in unreported cash.

As an example, you fail to report $10,000 in cash and you use it to meet personal expenses. You think to yourself, I would have had to withdraw at least $13-14,000 in payroll to have net that $10,000 so I have saved myself $3-4,000!

Once again, forgetting for the moment that the above would be illegal, there is another unintended consequence of the above practice. Had the $10,000 remained in the business it would have contributed to profits (and ultimately "excess earnings" calculations) which in turn would have been subject to a multiplier ranging between three to five, or an increase in company valuation of $30,000 to $50,000!

Ok, so you don't take cash out of the business, but you use the business to pay for certain personal expenses such as lawn care or electrical work done at your home. Such actions are more likely to be classified as "tax avoidance" as opposed to "tax evasion" and thus the penalities are not quite as severe.

Nonetheless, when it comes time to sell your business and you must calculate your total owner's compensation (including perks), you will be tempted to list many of these types of payments as perks. First, be prepared to document each of these payments to a prospective buyer. You claim an additional $2,400 for pest control as a personal benefit since the payment is made by the company. Be prepared to show the potential buyer invoices that will document these payments.

Just remember, however, that every unreported dollar, while saving you cash in the short-run, may be costing you you $3-4 in valuing the business for a future sale!

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