BERKONOMICS

We have discussed why never to run out of cash.  This insight delves into how never to run out of cash.  There are four basic ways to increase the cash position of a company:  inject cash through borrowing or investment, decrease spending or payments on debt, increase efficiency of operations, and increase revenues or advance payments from customers.

Even before examining the tactics of cash flow management, we’ve got to acknowledge that you never, ever should slip on payment of payroll taxes.  The temptation to do so in tight times is tremendous, but the liability for such taxes are personal to senior management as individuals and cannot be waived or negotiated away.  I advise all of my companies to use an impressed payroll service, one that takes the taxes from your bank account along with the net payrolls each period.  I have a story about this for later in this insight.  A close second for the same reasons are sales taxes and income taxes.  Both of these take a bit longer for the appropriate authority to move to freeze accounts because the processes of doing so are more involved. But all forms of tax must be paid to avoid catastrophe, if not merely avoid 25% penalties.

[Email readers continue here…] Let’s examine decrease in spending first.  There are several classes of obligations and several types of providers within each.  Assuming that the company is not already on the “cash only” list from materials suppliers requiring payment to those just to keep the business flowing, then when cash is tight, payments to ongoing providers of necessary services or products must rise near the top of the list.  If there are several alternative suppliers of the same service that regularly deal with the company, then you have more power in lengthening payments to one.  Calling vendors when payment is due but missed is always appropriate and will buy the company time and good will.  But promises made must be kept, even if the amounts of payment are small.  Some people advise that a company make small payments of any size to most all vendors, stating that these will keep the wolf from the door during tough times.  I agree, but spreading the cash prevents making significant payments to those vendors needed most for continuing operations, and the balance is worth careful consideration.

In general, next in line are those that charge stiff penalties for late payment, including landlords and credit card companies.  Often last are the lawyers and accountants who protect you and help you to plan your recovery, only because they above all others are vested with you in your recovery and success.

Accelerating revenues comes next.  Close supervision of delinquent receivables is time-consuming but absolutely necessary. There are statistics that show clearly that the likelihood of payment drops quickly as receivables age beyond terms.  And I’ve seen many company receivables clerks do a stunning job of collecting right on time by calling a few days ahead of time to check on the progress of a pending payment.

Thirty years ago, I stretched to buy a new home for my family that was above my ability to borrow at the time, but a bargain in a fast-rising market.  My solution, aside from a first and second mortgage, was to call a number of my best customer CEO’s, explain the problem-opportunity and ask for early payment of receivables.  I promised each and later delivered a boatload of extra value for that evidence of good faith.  As I recall, every one of the CEO’s agreed to advance payments, and I did reward them with extra services.  What may have seemed as a sign of weakness turned into a long term celebration of mutual trust and respect among peers.

Many companies have recurring revenues, often billed in advance, for maintenance or other services.  Merely sending out the invoices for each period’s pre-billing up to a month in advance of the start of the period will accelerate cash flow considerably.  Many companies ask for deposits before performing services. Increasing the percentage of a contract as deposit is often unquestioned by small to mid-sized customers.  Large corporations, those probably most able to pay such deposits, are usually the first to push back, often quoting “policy”, whatever that is, as the authority preventing compliance with such a request.

I promised a story about payroll taxes, and it is not a good one, despite the best of intentions.  One of my companies where I serve as chairman used a payroll service company that impressed payroll taxes along with payroll employee direct deposits and remitted those taxes directly to the authorities.  Well, almost.  One quarter, the company just did not receive its copies of the quarterly reports.  I had wisely suspected this payroll company already and had the company switch to QuickBooks Payroll at the start of the new quarter.  It turns out that the two founders of the small payroll services company absconded with (stole) all of the taxes from all of their payroll clients from mid-May through end of June that year. Since no tax authority notified any clients during those weeks no-one was aware that the money was gone and forms never filed.  Millions were stolen.  It is now years later, and our company as well as others have double-paid all the taxing authorities those missing taxes, including interest, but with penalties waived. The two founders are in Federal prison and about five percent of the missing funds were recovered by the Justice Department and returned to the companies.  So it seems that even conservative cash tactics such as using an impressed service for payroll can lead to disaster.  Who knew?

Now we turn to the more pleasant issues relating to growth, and explore some of the areas rarely considered when the rising tide lifts all boats.  Those of us who have experienced exhilarating growth have stories to tell that make it obvious that the thrill of the wild ride makes the effort more than worthwhile.  But growth has its issues too, and it is time to explore these.

How many of us have “hired” independent contractors over the years, a bit worried over the gray area between employee and contractor as defined by the IRS?  I’ve experienced the results of a wrong decision, and the IRS and state agencies are not forgiving in their pursuit of penalties, interest and most damaging, assessing a company with both the employer and employee taxes when reclassifying the person as an employee.

Yes, that’s right. The company must pay the employee’s portion of the taxes (and penalties on these) as well as paying those they would have paid if the person were an employee.

And the IRS has raised the bar on its test as to whether an independent contractor is not in reality an employee.   So it is important – no really urgent – that we review some of the twenty – yes twenty – tests the IRS now uses to determine if a person is an independent contractor.

1.  Contract for service:  An independent contractor should work under a written contract with the company, defining the end result expected, time to achieve, lump sum or unit cost, ownership of intellectual property created and more.

2.  Direction: The contractor directs itself, rather than being managed as an employee.   And just as important, a contractor does not supervise any of the company’s employees directly.  This is tricky when a contracted CFO assumes a position of directing an accounting department.  Usually, in acceptable cases such as this, the contracted executive comes from a recognized agency with a history of paying its own employee taxes, health insurance and other benefits.   Without this protection, a contracted executive is suspect, even if working with more than one company at a time.

[Email readers continue here…] 3.  Integration: A contractor provides services which are not an integral part of the core business of the employer.  This one is tricky.  Is a contracted CFO an employee because the CFO job is integral?   How about a contractor CEO?   The person must pass all the other tests when one of them such as this crossed into the very gray zone.

4.  Individual on the job: A contractor may hire a substitute without the company’s permission – although the company should then be able to terminate the contract with the contractor if the substitute is not acceptable.

5.  Term:  A contractor is hired for a specific project, usually tied to a time term. An undefined period of time favors the ruling as employee.

6.  Reporting: Here is a surprise. The IRS wants to test that a contractor is NOT required to submit regular reports.  Yet, most of us would want to have such documentation of progress other than an invoice.

7.  Tools and materials: The contractor must supply his or her own tools.  This is tricky when a contractor sits at your desk using your computer and your phone system all day.

8.  Physical facility: The contractor must have its own “home office” even if in a bedroom, from which primary work is performed.

9.  Works for more than one company:  If such a person works only for a single company for any period of time, that person will probably be determined to be an employee.  A contractor must make services available to the general public.

10.  Termination: A contractor works under a contract – which means that an independent contractor cannot be “fired” as long as results are satisfactory as defined within the contract of service.

There are more tests, but these are the ones most often used by the IRS.  States add a few of their own; so beware.   Pay contractors using account payable systems, not payroll services.  Pay only upon receipt of invoices, not with regularly triggered checks or transfers of uniform amounts without invoice documents to back up the payments.

Many small or early stage company CEO’s look for opportunities to cut cash drains, knowing that payroll is usually the greatest cash drain of all. The temptation to reduce that by fourteen percent or more by classifying a gray area employee as a contractor is very high.  And that includes self-payments to a founder.

Founders working for a company are employees if they take regular payments, subscribe to company benefits, attend regular company meetings or fail any of the tests above.  The temptation to just draw cash and call it a loan, or document a year’s withdrawals with a 1099 is great, but highly risky.

There is nothing worse than a large tax bill and threats of a government agency seizing a cash account when a company cannot or does not respond with proper documentation or payment.  And even a single year’s worth of transgressions, when added into a single tax bill with penalties and interest, can appear daunting to small and young companies.

Like payment of payroll taxes by incremental impound each pay period as opposed to waiting until the last minute and making manual tax payments, it is a proper discipline of management to “take the hit” incrementally to protect the business from a catastrophic failure to pay a governmental agency any form of tax when and as due.   Need we emphasize the personal liability of management AND the board of directors attached to tax payments?

Good management takes discipline and enough knowledge to prevent these possibly crippling errors in judgment that stem from decisions made to avoid or put off tax payments when accrued or due.

Almost all laws dealing with employment are designed to protect the employee, not the company. Minimum wage laws, workplace safety, independent contractor tests, minimum hours required for benefits, worker compensation insurance requirements and more are examples of such laws.  Notice that every poster that is required to be displayed in a company public area (usually the lunch room) is posted for the benefit of the employee to inform him or her of rights granted by law.  To most entrepreneurs, this often leads to an event whose resolution by a governmental agency or even a court seems unfair and illogical.  Issues that seem clearly based upon ineptitude morph into age or gender-related epic battles that most always end poorly.

So my advice is simple.  Recognize the realities of the times, and do all possible to protect the company by documenting behavioral or skill related problems to the employee file.  Hold regular reviews for all your employees right to the top. (The chairman reviews the CEO, and if there is no separate chairperson, then the CEO should ask an outside board member to do so.)   Encourage reviewers to be accurate, not just polite, in documenting areas of concern.

This is not to counter the advice of my earlier insight, “Fire fast, not last”, since every CEO should shoot for “A” class employees and not tolerate under-performers over time.

This is one that early stage CEO’s are almost universally unaware of.  Most every state requires that any company with employees be covered by a policy of insurance against claims by workers for injury on the job, or worker compensation insurance.  Many states has privately owned but state-overseen state insurance funds for this purpose, and of course a number of private companies offer such insurance alone or along with business package policies.

In this increasingly litigious employment environment, it is mandatory for a company of any size to maintain worker comprehensive insurance.  I have experienced incidents of claims that seemed quite minor on the surface where the employee was able to claim and receive large payments, sometimes over extended periods, for carpal tunnel injuries, slips and falls, neck injuries and more.  Claims worth half a million or more are not uncommon.  It may seem like an employee’s lottery win to management, but the fact of the insurance award is real.  In most states, the CEO and other executive owners of the corporation may be exempted from the policy and the costs reduced accordingly.  Also, each employee is classified according to job performed, with some drawing very high premiums relative to others.  With your agent’s help, you should be very careful to place employees in the proper but most advantageous class for the sake of the policy.

Also, you will find all insurers asking for an estimate of gross payroll costs in advance of each policy year. At the conclusion of each year, before renewal, the insurance company will perform an audit of your payroll and bill the company for underestimated amounts, or credit the company for overestimation.  These audits are often merely by telephone to your bookkeeper for small companies, rising to physical audits of submitted documents or in person for larger enterprises.  Treat such policies seriously.  For a reasonable cost, they protect against the strangest and saddest of employee-based corporate liabilities.

This insight seems obvious to most anyone.  But it is a fact that business insurance is one of the more poorly managed mitigation of risk in small and some medium sized corporations, often because of failure to assign the responsibility to an individual or department, and sometimes just from the willingness to bet against the event and save cash.

Business package policies are inexpensive and rather comprehensive tools that should be contracted by all companies with any assets to measure and protect.  A typical beginning package for a small company costs about $4 thousand a year, and covers a number of forms of liability both premises and product as well as employee use of self-owned cars for work, theft, employee dishonesty and more.  There is usually a small amount of business interruption insurance in the standard package, and more protection can be added at a cost.  Reading the list of protections is both impressive and frightening, since most of us never think of such risks, and it is overwhelming to have them pointed out in one reading.  Conversely, the list of excluded protections is equally frightening for the same reason.  We do not think of these unless someone points them out.

[Email readers continue here…] I believe my former software firm was responsible for one such exclusion that used to be a standard part of such policies. (Sorry about that.)  With almost 250 employees, 26 of whom were application programmers, it was important to back up the work of these programmers each night, and an employee was tasked with just this each evening after midnight.   Each night’s backup would be carefully marked and the rotated between offsite and on-site locations in a series of steps so that backups of a day, two days, a week and a month were all available both on site and off site.  Did I fail to mention that for more than a year we never tested whether the backups actually contained good data?  It seems that a change in the operating system on the server we used for development was made that changed the way backups were cued, and our backup person was unaware of the procedural change needed to accommodate this.  Came the inevitable day of the massive head crash, I quickly heard of the problem and the fact that all 26 programmers were standing by waiting for the backup to be restored, expecting to lose the partial day’s work.

And the first backup from the night before was blank.  As was each subsequent backup, on-site and offsite.   It took weeks for the team to assemble code from various sources such as customer sites, beta test locations and demo machines.  Then it took another several weeks for the programmers to come back up to speed rewriting patches and programs in a frustrating recreation of weeks and more worth of previous work.

I tasked our accounting department with collecting and calculating the costs of the labor lost, which was the only real claim for business interruption to be made as customers were unaffected by the problem.  The cost came to well over $100 thousand, and a claim was filed with the business package insurer. After a short negotiation and quick audit, the insurance company paid $108 thousand to settle the claim.  In the following year’s renewal policy, I noticed a new page in the exclusions section, excluding for the first time data losses from failed backups, no matter what the cause or where the fault.  As I recall, the year was 1987.  Either we were the first to make a significant claim under this previously covered portion of the policy or one of several that did so in that year. Either way, you have me to blame for one more of those exclusion pages that overwhelm such policies today.