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I found a fascinating read: it’s a Forbes article by Stephen Denning called “Why Amazon can’t make the Kindle in the USA.” Denning looks at the impact of outsourcing on the creation of next generation businesses.

He quotes some interesting stats. Only 2.7% of US consumer spending in 2010 went to goods and services “Made in China.” And of every dollar spent on an item from China, $0.55 went to services produced in the USA.

Here’s his question: Since spending on Chinese goods is only a sliver of the US economy, there’s no problem, right?

And here’s the problem: that tiny sliver happens to be the sliver that matters. Decades of outsourcing manufacturing have left US industry without the means to invent the next generation of high-tech products key to its rebirth. The author asserts that once manufacturing is outsourced, process engineering expertise is lost. And when process engineering talent is gone, research talent focused on the next generation of technologies goes with it: “In the long term an economy that lacks an infrastructure for advanced process engineering and manufacturing will lose its ability to innovate.”

Current thinking is that what’s happening is a normal evolution of business towards newer, higher-potential opportunities. That’s a mistake, because new, cutting-edge, high-tech products often depend on the knowledge base of an existing mature industry. Once you lose that knowledge base you lose the opportunity to be the home of hot new businesses tomorrow.

What I found particularly interesting in the article were prescriptions for a strong business future. The suggestions include: business leaders recommitting themselves to continuous innovation; accountants putting emphasis on how companies can add new value rather than just cut costs; investors rewarding companies that engage in continuous innovation; and governments playing a bigger role in protecting and promoting the government agencies that have fostered the kind of technologies that require patience and deep pocketbooks.

The author believes the role of management needs systemic change to meet these future challenges. That systemic change includes new roles such as: commitment to continuous innovation, adopting a different goal of delighting the customer, a different role in enabling teams, a different way of coordinating work through dynamic linking and a different communication style using horizontal conversations.

This type of systemic change will be essential…and not just for big business. Small businesses and start-ups are especially likely to represent a disruptive technology of tomorrow.

We’ve heard a lot from the “99 per cent” over the last year. But a few months ago, Ontario’s government passed a bill aimed at the other “1 per cent.”

On June 12, Queen’s Park approved a 2% tax increase on those who have a taxable income over $500,000. This increase will be implemented gradually. The first percentage point hike came into effect on July 1, 2012, and the second percentage point will hit in 2013.

When you add it up, the highest combined federal and provincial tax rate in Ontario will be 47.97% in 2012 and 49.53% in 2013.

It looks like the new tax will only impact the top 1% of earners in the province…but I think it’s useful to see how income tax changes can affect income tax planning, even if you’re part of the other 99%.

One option for high earning unincorporated professionals, like a doctor, for example, is to include the use of professional corporations to carry on the individual’s professional practice. This can offer a significant tax deferral advantage. Some of the individual’s income can be kept in the corporation, and isn’t required by the professional to meet his personal needs.

Here’s how the deferral works. The corporation would only pay about 15.5% in tax on the first $500,000 of active business income and about 26% on income above that. That’s much lower than the forecasted 49.5% that would be paid personally after the new Ontario wealth tax is fully implemented.

If the corporation is set up properly, it can also facilitate income splitting among the taxpayer’s family members, reducing the family’s overall tax burden.

High earning individuals can also invest surplus income in a holding corporation. This wasn’t an attractive option before because of the refundable tax system we have in Canada. But with the implementation of the “wealth tax” comes tax deferral opportunities for those who earn investment income through a corporation.

After the “wealth tax” is fully in place, the effective integrated tax rate on investment income will be 48.86%. Compare that, again, to the 49.53% personal rate.

High-income earners who currently make a lot of money on their investments can income split with a lower-income earning spouse, or children and grandchildren. One way to do this is to make a prescribed rate loan (currently at a historical 1% low) to a family trust or spouse, so you can shift investment income to the borrower. This lets the borrower invest the money. The difference between the rate of return on that money and the 1% paid to the lender will be taxed in the hands of the borrower, not the lender.

We know we’re only talking about the 1% here. But a closer look at this tax can help anyone see how good personal and business tax planning combined with strong advice can reduce an increasingly severe tax burden.

If you or someone in your family has physical development challenges or a severe or prolonged mobility issue, accessibility changes to your home could save you on your taxes. Certain modifications are eligible for the medical expense tax credit (METC). The METC is worth the same as a deduction in the lowest tax bracket—which is about 21% in Ontario. It’s only available if your total qualifying medical expenses in any 12 month period ending in the current tax year exceed the lesser of 3% of your net income or $2100.

The most common types of eligible expenses include ramp construction, enlarging hallways or doorways, changing cabinet height and building elevators or stair lifts. You can also claim architect or engineering costs incurred in the renovation process.

There is a restriction. You can’t claim a renovation if it adds value to your home. A great example of this would be adding a hot tub or swimming pool. It may be necessary for therapy, but it also adds value.

The patient doesn’t need to own the home, but they do have to live there. That means modifications to rental properties or a relative’s house qualify as long that’s where the person with the disability lives.

There’s another area of coverage, too. You can extend the claim for modifications let help people in wheelchairs access a van. A portion of the cost of the van or the costs to adapt the van to make it accessible are eligible. The limit is the lesser of $5000 or 20% of the cost of the van.

A small disclaimer; as with most things you claim under the Income Tax Act, the home renovation expense must be reasonable in the circumstances.

For most small business tax planning and estate tax planning, being aware of every circumstance where there’s a chance to save on your tax bill really helps the big picture.

Managing your business’s cash flow is critical to success.

Imagine your operation is a river – and the cash flow is the water. You should be building dams and maybe shifting the banks to keep that water moving when and where you need it. All businesses need to invest in income-producing assets, like accounts receivable, inventory and equipment.

Very often what you need costs more than the credit you can get from suppliers—by a lot. To stop your river from drying up, you borrow from another source, like a bank or your own capital. Bank financing can be hard to come by for a new business, which leads to a lot of pressure for an owner.

In our experience as Chartered Accountants working with small businesses, we have seen most owners struggle with ‘water levels’: raising enough capital to make sure everything is financed effectively. If you don’t have enough, you’ll constantly be juggling cash flow to make sure you can pay wages and suppliers on time.

Earlier we looked at collections and cash flow management, offering tips to improve your collection cycle and help put cash in the business. Today we’ll look at ways to manage payments to improve cash flow availability.

Most small businesses choose to stretch out their payables first. This is a classic example of a works-in-the-short-term, hurts-in-the-long-term scenario. Suppliers will slow down shipment of products and services if they don’t see their money in an appropriate time frame. And that hurts your profits.

Here’s one possible solution: you can split purchasing between suppliers. It eases the pressure. But for this to work you need to have more than one appropriate supplier for your particular products.

You also need to make sure you only stock inventory that can be sold quickly. One of the biggest small business problems is having inventory sit in a warehouse for ages. It absorbs large amounts of working capital and ultimately reduces profitability—you’ll most likely have to drop the price to move the stock.

Businesses should always take advantage of payment incentives. Many suppliers offer terms such as 2% if paid in 10 days and net 30 days. If you forego the discount, you’re paying 2% interest for 20 days’ financing. That adds up to an annual interest rate higher than 37%.

We also think businesses should consider leasing equipment instead of owning it. This lets you spread out the cash flow requirements to pay for equipment over its useful life. There is often a higher interest cost involved, but it can be very advantageous in managing cash flow.

Management can also control the problem by investing time and effort into creating a cash flow forecast. As part of your business strategic plan, having this type of projection gives a solid indicator of when you’ll need cash, how much you’ll need and also when you’ll have a surplus. If you know how much money you’ll need for something, you make better decisions if you have to manage a shortfall.

For most small businesses, proper cash flow management is a critical determinant of business success. This is especially true in the early years. If you can direct your “river’s” flow, you’ll sustain a healthy business ecosystem for years to come.

With all our talk about small business owners and their retirement plans, hopefully we’ve kicked you into gear to think about your own. We’ve looked at a few of the issues and why it’s so important. If you’re like most entrepreneurs, your small business is the biggest asset in your portfolio.

Not to be dramatic, but the value of your small business basically controls the rest of your life. It determines not just the quality of your retirement life, but also when you’re able to kick back. As small business accountants meeting the needs of clients in the Greater Toronto Area, we can’t stress enough that to make sure our clients’ business grows at a pace that meets their retirement plans, they need to perform regular business valuations.

It’s critical for small business owners to understand how the value of their business is determined. To do that, you need to know the particular drivers that let you achieve maximum business value.

A business’s value is ultimately determined by its ability to generate future cash flow. The most common method for regular business valuations is to estimate future cash flows, while looking carefully at what may happen down the line to impact them.

In some industries, an asset-based approach is the way to go. Real estate companies are a good example. But even here, the real estate’s underlying cash flow is what mainly determines property value.

Often small business owners hear about rules of thumb in their particular industry. Those include the idea that selling value is a multiple of annual sales, size of customer base or gross profit contribution. Keep in mind these methods are really just substitute indicators for underlying factors that determine future cash flow.

So how do you figure out future cash flow? There is no exact business valuation formula, as each and every business is going to be different.

Here are a handful of the biggest factors to look at: industry and market trends, available management, strength of brand, unique relationships with suppliers, patents and trademarks and proprietary technology.

You need to perform regular business valuations to find out whether or not your business’s growth is consistent with your plans. What you learn in the valuation will also help you decide whether changes need to be made in business strategy, planning and development.

Defining your key business drivers through the valuation is a benefit. As an owner, when you lay those out and understand them, you can incorporate that info into your business strategic plan. That helps build future growth and profitability.

A recent article adds a modern business spin to our most basic set of rules. On the American Express forum, Barry Moltz writes about The 10 Commandments of Growing a Business. Many of these are concepts we at Silver+Goren stress weekly in our posts. There are definitely some lessons to be learned – or stressed again – and we think it’s useful to pass them along. Moltz’s 10 Commandments include:

1. Thou shalt watch thy cash flow. The most important financial statement to review monthly is the cash flow statement. Do you have more money at the end of the month than the beginning?
2. Thou shalt have a brand strategy. Think through the actual pain your business solves and craft a memorable brand around that message.
3. Thou shalt not grow thy company broke. Many entrepreneurs try to grow their companies too fast without the cash, people, systems or infrastructure to do it effectively. In the end, they eventually go broke.
4. Thou shalt keep thy current customers happy. Many entrepreneurs are so busy chasing new customers in the front doors, they miss their existing customers exiting out the back.
5. Thou shalt keep thy overhead low. Entrepreneurs go out of business because their fixed overheads are too high as their revenues fluctuate.
6. Thou shalt guard thy reputation and not speak badly of thy neighbour. In the Internet world reputation is your most valuable asset. Watch and listen to what customers say about you and never directly criticize your competitors.
7. Thou shalt get referrals from existing customers. Too many times entrepreneurs do not ask satisfied customers for referrals.
8. Thou shalt reward outstanding employees frequently and fire bad employees immediately. Everyone in your organization knows who the good and bad people are. It’s up to you to do something about it.
9. Thou shalt review thy financial statements monthly. Find an accountant who can explain them in terms you can understand.
10. Thou shalt take an annual vacation to recharge. This is necessary, not just to recharge yourself but to see how your business does without you.

A great overview, and even some overlap with those original two tablets. As Chartered Accountants working with Canadian small businesses we have found that the small businesses that follow most of these commandments have a much higher likelihood of success. Of course, nothing is guaranteed. But just as living by a few simple guidelines can help us in life, following another set can help in business. By demonstrating the type of vision, focus and discipline inherent in these commandments, you go a long way to increasing your chances of success.

We’ve looked at the number of entrepreneurs who aren’t prepared for the day they can no longer run their business. We’ve looked at why it’s so important to be prepared. Now it’s time to help.

Business succession planning model

What can small business owners do to guarantee they have enough to retire? With years of experience as Toronto Chartered Accountants advising small business, here are the top five strategies we recommend you choose from:

1. Maximize profits while running the business. For business succession planning in Canada, the goal is to have enough capital accumulated both inside and outside RRSPs to fund retirement, and then close the business.
2. Retain ownership of the business throughout retirement. It’s a good idea to play an increasingly passive role in day-to-day operations, while living off the dividends generated.
3. Transfer the business to the next generation.
4. Sell to an insider, like a partner or key employee(s).
5. Sell the business to a third party.

Each of these five retirement strategies has its own pros and cons.  Let’s look at some of the issues that come with each succession planning model:

1. Maximizing profits:  In order to maximize profits for the long term, you usually need more time and a lot more personal discipline. It takes a lot to put aside enough capital as it comes in each year to have enough to retire. On the plus side, the end result is totally within the business owner’s control.
2. Retaining ownership:  If you still own your business in retirement, you need to foster enough management talent to allow you to phase out slowly, while maintaining enough profitability to fund your retirement. It’s a much riskier strategy as the profitability of the business can suffer without the owner’s involvement. There’s also a risk new managers decide to start their own business and leave.
3. Transferring your business:  If you transfer your business within the family, you obviously need children who not only want to work in the business, but are capable enough to keep it profitable. You also need an appropriate transition plan. Usually families want to treat children equally. If some work in the business while others don’t, estate tax planning becomes more complicated.
4. Selling to an insider:  If you sell to an insider, you also need well-trained people who can run the business after the owner is gone. On the positive side, those insiders already know the business well and are likely willing to pay a premium price because of their intimate knowledge of the opportunities.On the other hand, they often don’t have enough capital to fund the owner’s withdrawal.  That means the owner funds the acquisition.  Then you’re asking for retirement payments out of future profits…which involves a gamble because there’s a chance the business doesn’t succeed.
5. Sell to a third-party:  Selling to a third-party is the most common strategy. It requires the most planning and the longest time frame. You need the right team to help, including strong management, legal counsel, chartered accountants, a business valuator and a financial advisor. The biggest advantage is the owner usually gets a big chunk of cash when they close, which reduces risk.

There you have it, five succession planning models and lots to think about. While one will be most appropriate for your business, there are several crucial strategies that should be on your business succession planning checklist:

• You need to organize and manage your business to maximize profitability, both to accumulate personal capital and to maximize the ultimate sale price.
• You need an appropriate and effective management team that can operate effectively without your day-to-day involvement.
• You need to start planning for the eventual sale years before it happens.
• You need to perform regular valuations of your business to make sure you’re on the right track to achieve an appropriate amount of money to fund your desired retirement.

As we discussed last week, there’s a huge number of small-business-owning baby boomers set to retire in the next decade. And a high number of those are not prepared for the next step.

So if that’s you … and you’re in the same boat as many of your peers … why is it so critical to get ahead?

Well, there are some major implications. As the number of people ready to retire grows, the number of available businesses for sale grows too. The rules of supply and demand are simple. As the sheer number of baby-boomer-owned businesses for sale increases, we’ll be faced with a true buyer’s market.

More supply likely means prices will drop—particularly for lower value businesses. Getting the maximum return for your investment of years of hard work will be much harder.

What you can get when you sell your business affects a few critical factors—namely your quality of life once you leave the company. But it also affects how long you’ll have to stay at work before you can afford to leave. And those are plans you need to solidify now. Not only so you can figure out when to retire, but also how to maximize your business’s value when you do choose to sell.

Knowing all that, why do small business owners do nothing? The biggest factor we’ve seen in our experience as small business accountants is that entrepreneurs are so busy working in their business they never have time to work on their business. We’ve talked about it here and here.

There’s another issue we see often, both in exit strategy planning and in estate tax planning. It can be a very emotional time – and your heart can loom larger than your head.

We’ve seen many small business owners with an emotional unwillingness to think about their personal future. It’s much easier to avoid thinking about retirement and mortality—for the short term, of course. But it can do serious damage for the long term.

Don’t delay your succession planning

Delay is not a viable option. To build an effective and successful exit strategy, you need to start the succession planning process 3 to 5 years before you want to sell.

Not having enough time is one of the biggest reasons small business owners don’t meet their financial goals. And when you mix procrastination with a growing army of retiring baby boomers, the odds are certainly not in your favour.

Make sure you have the right succession planning model in place to ensure a successful succession when the time comes.

As a small business accounting firm, we at Silver+Goren deal with the entrepreneur crowd frequently, so we talk a lot about building a strong foundation and plan for your business.

But what’s your plan when it’s time to retire? If you have no clue … unfortunately, you’re not alone.

The numbers behind succession planning

A TD Waterhouse Business Succession Poll showed three quarters of Canadian small business owners haven’t fully prepared for the day when they will no longer be running their business. Not having a succession plan can cause major complications down the line.

According to the small business owners polled, the top two reasons for being succession plan-less were ‘still trying to figure out a plan’ (45%) and ‘just haven’t gotten around to it yet’ (31%).

Respondents were fairly divided in what they want for their business when they retire.

The top options were closing the business (23%), selling it to a third party (20%), or transferring it to a family member (18%).  More than a quarter (27%) don’t know what they will do it comes time to retire. The last stat shows many business owners have not spent any time on exit strategy planning.

These stats become particularly concerning when you take them in context of small business ownership in Canada.

Right now most of the country’s 1.2 million small and medium-size enterprises are owned by Baby Boomers. It’s estimated more than forty percent of these entrepreneurs will leave their businesses within the next five years and more than 70% within the next decade.

Think about the massive transfer of wealth behind these numbers. The retirement tidal wave will have significant impact on the lives of the small business owners and their families.

For many, the value accumulated in their business is the biggest part of their life savings. Making sure this transfer is done in the most effective and profitable manner is critical to the quality of retirement for most small business owners.

Succession planning best practices

In the next few weeks, we’ll look at some of the issues for small business succession planning, and check out how they fit with your business strategic plan. Because plans aren’t just for the beginning and the middle…they need to reach the end.

At Silver+Goren, we often take a closer look at why so many new businesses fail. A recent Globe and Mail article zeroes in on a smaller category – here’s their list of 10 reasons family businesses fail:

1. Poor succession planning. Without an appropriate plan and road maps, failure is inevitable.
2. Lack of trusted advisors. Advisors often only have technical skills without developing a more sophisticated level of understanding.
3. Family conflict. That’s an obvious one – no proper procedures to manage family feuds.
4. Different visions between generations. Generational conflict can hinder growth.
5. Governance challenges. Family and shareholder governance infrastructure is essential.
6. Exclusion of family members outside the business. Every family member, active or not, has an investment in the business.
7. Unprepared next generation leaders. The new generation can’t be parachuted to a top position at the last minute.
8. Poor business strategic planning. Good planning motivates and keeps the family in business through challenging times.
9. Not using their family’s advantage. Failure to brand the business to include the unique resources embedded in the family business.
10. Fundamental principles of business are not applicable. Having fundamental business training is not enough to cope with the unique dynamics of the family business.

If you want more information, the article gives an in-depth look at each issue.

We’re most interested in the number one reason: poor succession planning.

As small business accountants in the Greater Toronto Area, we see it over and over again…with sometimes disastrous results.

Over the next few weeks we’ll be looking closely at the who, what, why, and when of successful succession planning. (Hint: the when is RIGHT NOW!)  We will give you our insight based on years of experience, and tips your can use to make sure your small business plan is on the right track.