This story is the most illustrative, as it contains almost all the mistakes that a business owner could make. You can see what this leads to.
The backstory is this. The owner had 5 gas stations, each of which had something like a small canteen. There were a few tables where customers could sit and eat, but mostly they took food to go. Accordingly, there was a small kitchen, a shop that sold cigarettes, and beer - as usual.
We came with an investor there. And the first impression was very good. Because everything is in one place, these gas stations were in very good places, next to the freeways, and there was a large flow of customers. We sat as customers and saw that cars were constantly driving up and leaving; there was also a queue for food.
But all our illusions were dispelled the moment we started checking the business. With us, every time before a deal is closed, the investor, if he is, of course, in his right mind, checks financial indicators.
And then this picture appeared:
- How gas transactions were registered. Each pump had a credit card reader, but the data all went to the company that supplied the oil. From the oil company came compressed information. Every payment was documented.
- What happened behind the store shelves?
The store used electronic cash registers, but these were not connected either to each other or the accounting system. The store operated around the clock, as gas stations usually work, and each shift handed over a control tape from each cash register.
They had a fairly large office. Two employees sat in one of the rooms and collected all the information about the cash register, about what came from credit cards, and entered all this into an excel spreadsheet. This is the most common and hardest mistake when people themselves invent their system of how to keep records. Naturally, whatever they invent will always be worse than working with qualified specialists.
The story doesn't end there. Although there were two people ONLY engaged in accounting, reports for taxes were prepared by a special company CPA. There, once a quarter, several boxes with primary documentation were taken: invoices from suppliers, bank account statements, etc. There were also several bookkeepers at the CPA who drove data into the system. Based on this, they generated financial statements and calculated the taxes that were due.
And then we read all these reports and found that the cost structure was somehow strange. Typically, gas stations have very low margins. Oil companies let you earn 2-3 cents at the most per gallon; this is not something that transforms into millions. And this owner's margin was several times higher. So, it caught our attention. We requested documentation from the CPA and saw that in some months there was a jump in the direction of increasing profitability (actually reducing costs). The strangeness that caught our attention all boiled down to the fact that in some boxes there were not enough invoices. And this CPA did not notice at all that in one month the profitability was 10 times higher than in the rest; he simply brought it all in and gave it to the tax office. Profits were inflated, which meant higher taxes. This owner said that the CPA could not be wrong, that the tax office was wrong. He argued there, the tax office pressed on him, and this man hired lawyers who fought with the tax inspectorate. By the time we met him, the lawyers' bills were $70,000. Whether or not they figured out the reasons for this situation, they continued to issue their bills mercilessly.
By the way, with all this, the owner took money out of the cash register and put it in his pocket. Thus, he hoped to underestimate taxes.
Now we can make a short list of the mistakes the business owner made.
- The most common mistake: he invented a method to reduce the tax base. He was trying to increase his profitability by cheating the tax collector.
These methods are invented the same, we do not see any diversity. Thousands of businesses use one or two typical tricks.
The IRS is well aware of them.
- Messy accounting.
Even though there are a lot of all kinds of accounting devices, the mess is complete. They were not in a position to tell us anything about profitability, about how it is controlled. As already mentioned, this led to the fact that they overpaid tens of thousands of dollars to the tax office.
- All this was based on a typical mistake when there are several accounting centers in one business (for example, several cash registers or several places where there are several cash registers).
It wasn't tied into one computer system at all. Employees brought the register control ribbons, the girls took them, and adjustments were made regarding the seized cash. They entered something into Excel, and it was impossible to mold it all into a whole picture.
We repeat once again that this is a blatant example of how pointless and harmful all these attempts to deceive the tax authorities are.
- The physical movement of documents, unlike data in the electronic form, always leads to their loss, which completely distorts the picture.
- Even if there is a double system (I took $1,000,000 to the cashier and took $800,000 to the bank), then there is a difference - this is the amount that is not subject to taxation.
But this is all very naive. As a result of this operation, they completely lose control over true profitability, over the real ratio of income to expenses, and are not able to control possible errors in the process.
This leads to overpayment of taxes. The owner was trying to get out of a situation where he underestimated the tax base, and then paid more in tax than was necessary. If the tax office clerk understood what was going on with the owner and was able to check the data, then he would either immediately understand what was wrong or could control the work of the lawyers. And so, the tax office told him: “Yes, we will make all the calculations. We will return the excess taxes.” But, all that happened was that tens of thousands of dollars were overpaid to the tax collector.
What are the underlying reasons?
- The ingenuity of people who want to increase their net profitability through lower taxes.
They begin to invent schemes that lead to a large amount of cash, which is withdrawn, but to a greater extent leads to negative consequences (destruction of accounting, at least).
- All these people are experts in their field; they know how to organize the work of restaurants and filling stations. Yet, they are completely unwilling to master even the fundamentals of accounting.
Considering that they had a rather complicated business, hundreds of transactions every day, tens of thousands a month, efforts were required there.
A common situation: they keep records at home and then transfer the data to an external outsourcing company that keeps accounting for them, but these companies are also not able to check all this to understand where there are contradictions. They just enter data mindlessly into the system. Accordingly, a counterflow of a blind exchange of letters of trust is obtained. You need to understand that the CPA has limited opportunities to reconcile primary documentation. Therefore, they force the owners to sign a letter that says: "We make your reports based on the information that you provided us, and we do not bear any responsibility for the result." The owner signs without looking, and then such situations occur. As a result, the tax office can get more money, and no management accounting can be done on this basis.
What is the result?
When the question arose of how to assess the real profitability, the investor said: “You know, given the state of your accounting and the abundance of the business primary documentation, it is impossible to carry out restoration accounting. I'm not in a position to make a million-dollar decision based on this mess instead of information." Accordingly, when investors get into such a mood, when they see the state of accounting and understand that they cannot check anything here, the market capitalization of this business falls.
As a result, the owner constantly goes through the stress of checking with various potential buyers; he is constantly “dipped” in mistakes.
How can YOU avoid or correct this situation if you find yourself in this enterprise?
The first thing to do is to set up the account properly. This is one of our CLASSES - how accounting should look when there are retail sales at different locations. And secondly, you need to understand the basics of corporate taxes. When you understand how all this is calculated, you understand the futility of all attempts (withdraw cash from the business, rewrite invoices, etc.), because the result is meager, and trouble is guaranteed.
Therefore, we recommend that you, before entering into these negotiations, go through our CLASSES so that you can evaluate the business in terms of how you will manage it, whether you can fix it, and whether there are potential threats.
For successful business immigration, work with reliable people - Investors Magnet.
