jad andbook for Small Business By SCORE Chapter 225 Hyannis, Mass. Series Building America’s: Futurea) ‘Copyright © 1989 by SCORE Chapter 225, Hyannis, Massachuaots. All rights reerved. This publication is protected under copyright. [No part may be reproduced, transmitted or irarscribed without Che permission ofthe auhor, SBA teisins an ievoenble, worldwide, ‘mocenclusive, cayalty Gee. untiited Hoonso to use this copyrighted material ‘While we consider the concens ofthis publication to be of general meni, its sponsorship by the U.S, Small Business Admiistation ddoos not aesevsarly constitute an eraoesement ofthe views and opinions of the authort or the products and services of the companies ‘with which they are affiliated All of SBA's programs and services are extended to the publte on a nondiscriminatory basts.CONTENTS PREFACE oo... ccc ccesecseeeeetees INTRODUCTION .... . STARTING A BUSINESS ... NAMING A BUSINESS . LEGAL STRUCTURE OF A BUSINESS. Soe Propitreip- Partnership. Corporation «. “Subchapter $ Corporations LICENSES AND PERMITS. MANAGING A BUSINESS Management by Objectives Keeping Records . aviewing Records ‘Taking Action Getting Help . Essential Management Practices FINANCING A BUSINESS: Sources of Funding The Lean Proposal ‘THE BUSINESS PLAN RECORD KEEPING .... PRICING SERVICES PROFITABLY Typesof Costs .. Calling the Gostota Sentce PRICING PRODUCTS PROFITABLY ‘Typesof Costs... - Broak Even Analysis ADVERTISING Reasons tor Advertsing Chjectves of Advertsing Adverising Media. Help in Advertising MARKETING Matating Bove Opening... Marketing for an Existing Business .. US. Smal! Business Administration iLOCATING A BUSINESS: Selecting a Ciy or TOW... ‘Selecting an Area Within a Cily or Te Selecting a Speciic Ste .. INSURANCE .... se BB 228 12 24 RETAILING TIPS, Image ......-... Customer Relations, Credit Cards Markdowns Loss Leaders . Pricing Poy. Leases . Protecting Compebiors Empoyees ‘Suppers . EMPLOYEES AND INDEPENDENT CONTRACTORS: or 28 28 MANAGING HUMAN RESOURCES. Recruiting 29 Ineriewing 29 Wages and 0 Training 30 Supecision 30 Terminating Empieyment : COMPUTERS IN SMALL BUSINESS What a Computer Can Do... ‘Aes a Computer Can improve Wal a Computer Cannot Do Buying a Comput... FRANCHISES Detriton . Aavantages Osadvamages .. Osclosure Document. ‘Other Consierations MANUFACTURING COST ACCOUNTING INVENTORY Invertory Record Keeping Invertory Contal... Invertory Stratogi: APPENDIXES ‘A Useful IRS Tax Publications B. Information Resouroes 4“ 4a « US. Sait Business AdministrationSCORE, an acronym for Service Comps of Retired. Executives, san independent, voluntary, nonprofit association. Altiough SCORE is sponsored by, and receives financial aid from, the U.S. Small Business. Administration (SBA), itis mot a constituent of thal oF any other government agency. “The primary purpose of SCORE is to reader a community service by providing, without charge, the expert assistance ofits volunteer counselors to small businesses. ‘Counselors rective no pay for their services. SCORE began ‘n 1963 when certain groups of retired persons, almast spontaneously, began offering assistance {o owners and operators of small businesses in various localities, such as Worcester, Massachusetis; Wilmington, Delavare, and St, Lou's, Missouri. Later in the yea. the 'SBA began to use these volunteers :o supplement its own. ‘small business assistance programs and to recruit more volunteers for that purpase. ‘The respoase was 50 enthusiastic, and the potential of ‘these volumeers so enormous, thal the SBA began to ‘organize local SCORE chapters and administer the ‘rogram. Today, there are more than 400 SCORE INTRODUCTION {In this final decade of the 20th century, small business ‘owners continue to demonstraty their extraordinary capacity wo mobilize resources and generate new jobs. ‘Thero are more thsn 20 million small businesses in the United States, and each year nearly a quarter ofa million ‘new ones are started. Smal! business employs six out of every ten people, accounts forthe majority of new jobs, is ‘more Gexible than big business in responding to shifting markets and is able to bring new produets and services to market much faster than larger companies, ‘Realizing that small business is the backbone of his country's competitive free enterprise system, Congress, 39 1953, created the USS. Small Business Admicistation, SBA defines a small business as one independently owned and operated, and not dominant in its ek. SCORE is part ‘of the SBA’ business development program. ‘To star a new business and remain in business profitably, ‘one must be able to adapt to changes in the population, ‘work force and technology, and tothe demands of ‘lobal marketplace. To address these changing sonditions, sound management and organizational ‘chapters in the United Seates and more than 12,000 volunteers. ‘While its counselors derive tremendous personal gruification from assisting small businesses, SCORE exists solely forthe benefit of the small business ‘communicy. For anyone in, or considering entering into, a small business, SCORE offers many services. These services include private, individual, confidential ‘counseling; training through specialized seminars, ‘workshops and conferences; information from books, pamphlets and SBA publications, and advice on how «0 approach regulatory organizations. local authorities, lawyers, accountants, town officials, etc. Also, SCORE cooperates closely with ether volunizer organizations, -govemment agencies, chambers of commerce, colleges and universities, and other nanpoltical civic associations to enhance the quality of life forthe entire community ‘To locate the nearest SCORE chapter, call your area SBA. office. The number is found in the blue pages under “LS, Government.” You can also call SBA's Answer Desk at 1-800-U-ASK-SBA. Practices are more important than ever before. The ecessity of increasing productivity of employees, the Analyze progress with hard nombers, ‘© Know your break-even point and when you are 02 target in reaching it ‘Have your accountanvbookkeeper prepare ard thoroughly explain financial reports, such as profitand loss statements, balance sheets and cash Dow sheets, in adition to those related to ‘your tax returns + Evea though your objective may not be to socure loan, talk 10 your banker about your business. Know your numbers. © Know exactly how much itcosts you to make a sale, perform a service, make a repair, ets ‘+ Know how muck inventory isn hand, tnventory ismoney. Old and obsolete iavemtory can paralyze your busines, © Solicic regular feedback from customers and make changes based on their suggestions. «+ Join a trade association for your industry. ‘+ Read the same publications that your competitors and customers read. e U.S, Small Business Administration‘© Constanuly serutinize your competitors’ ‘advertisements and read thei sales literanure. ‘+ Ask yourself the following about your competition: Is their business increasing or decreasing? How do you compare as far as quality, price, pnduct line, exclusivity service, reliability, location, warranues, delivery end ‘courtesy are concerted? «Tali regularly aboot business-relazed subjects ‘with other small business owrers. «Review financial and marketing strategies often ‘+ Have regular raining sessions for and regular ‘motivation mectings with your empioyees. + Recognize your own wealmesses and get help in these areas. ‘+ Review the business plan monthly. ‘+ Tell everyone on the payroll exactly what his or ber responsibilities are and what is expected. ‘+ Treat employees as individuals. ‘+ When an employee does a good job, tll hinw or her. + Keep as accurate a set of records as possible. ‘© Analyze your records oftea and talc any appropriate steps that may be indicated. ‘© Take pride in yoor business. Gees) ee ess) ‘One of the leading causes of business failure is insufficient stat-up capital. Therefare, a crucial element for business success is adequale financing. Not only are funds required for start up, but also to cover initial operating losses and provi for growth. ‘Asa general guide, one should have sufficient cash to cover atleast one year’s operating expeascs, which includes the owner's salary and money to make regular Joan payments, Almost al businoss operators hope theit bosiness will grow, yet some fail because, after a successful start, additional capital is not available 1o meet ths increasing financial demands of an expanding ‘wasiness It is crucial that che business plan contain @ etailed snatysis of alt capital requirements, ‘Once you have determined the amount of capital required to both start and continue the business uni] it generates ‘enough cash 10 sustain itself, it is time to find a source of money. Sources of Funding Personal Assets. The best source of funding is your personal resources, such as savings accounts and other marketable securities and investments chat are readily converted ino cash. Even it you do not have sufficient personal funds to entirely finance the business, plan on using those funds, becanse most lenders require that you do this before they will corumit toa oan. Remember, showing others you are willing to use your ows funds indicates your confidence in your business and your willingness w tke the risk. amy and Friends ‘An excellent source of funding is your family and friends. Either can make a capital investment the business in return for partial ownership or asa loan. Usually, family OF friends will lend their money ata lower inerest rate than a commercial lender and with mutually agreeable ‘erms for repayment, {tis very important in your dealings with family and. friends that you carefully review your business plan with ‘them so that they understand all the risks involved. Family and frieads should not be encouraged to invest in your business if they cannot afford to risk their funds. For IRS purposes, detailed recards should be kept of any financial assistance received fram friends ot relatives. ‘Also it is recommended that a writen agreement with the individual providing fonds be prepared. Banks ‘Banks are the mast commen source of borrowed capital Historically, commercial banks have been the single largest source of loans w business. Today, however, both savings banks and savings and loan associations make ‘business loans, tis very important to establish a cordial working relationship with your banker, Pick a bank tha makes Jams to your particular type of business and ane with US. Simall Business Administration 4s‘which you feel comfortable, Your banker can be a valuable partner in helping to determine the right financing package for you. ‘A bonk normally requires tha first-time bortowers invest from 25 w 3$ percent of their own money before the bank ‘will consider a Joan, For example, ifthe business plan shows a necd for $100,040), the borrower would have 10 hhave 825,000 10 $35,000 of his and her own money in ‘order 10 obtain $65,000 to $75,000 trom the bank. nthe case of a restaurant, the bank may require the borrower to invest 50 pesvent of his or her own money. Banks require that you have a good personal credit record and, in most cases, will quire some form af collateral 10 secure the loan. Collateral can be inthe form of assets used in the business or personal assets, including the unused equity in your home. Creat Unions Many companies, labor unions and government agencies bave credit unions for their employees or members, Credit unions pecform Functions similar fo barks, ‘nclading making personal loans to their members. Ifyou are a member of «credit union, heck it out asa possible source of a business loan. [Loan and Finance Companies “These axe companics that specialize in making personal loans for business purposes. Some of the larger ‘companies make business loans as well as personal loans. Le Insurance Companies: ‘Many life insurance policies have provisions for the accumulation of a “cash value,” against which funds may bbe borrowed. Some policies call it the “loan value.” The interest rate, established in the policy, is usually less than the commercial rate. Chack to see if you, parenis or friends have life insurance with Joan values as they can be an excellent source of financing. ‘Small Business lavestment Companies mat! business investment companies (SBICs) axe privately owned companies licensed by the SBA to provide capital ce small businesses. SBICs look for businesses that have propcctary products with high growth potential. Young. lower-ris, aggressive ‘companies are preferred. Usually, an SBIC wants a share in the business, Community Development Companies ‘Many communities have established community development companics (CDCs) to help attract new bbasiness to their area. Frequently, they are used to develop commercial or industrial parks, Check to see i your community has a CDC, If so, you should talk te them. Suppliers |n order to encourage sale of their products, many suppliers provide retailers with shelving, display cases, xeffigeration units and so on at very favorable terms, Caution should be used when financing assets through a supplier, be sure you understand any commitment you ‘have to make regarding purchasing the supplier's product ‘in the future ‘Also available from many suppliers are extended payiment terms, enabling you to sell the merchandise before having to pay for it, A supplier may offer goods om consigament. Leasing Companies An allemative to purchasing equipment with borrowed ands is 1 lease the equipment. Items conumonly leased are office furniture, automobiles, sucks, computers and production machinery. The leasing company maintains ‘ownership of the item, although sometimes agreements an be made by which you become the owner after a specified time period. Leasing allows you to conserve initial capital and offers: fleniiity in acquising Une use of equipment far oly limited period of time. Private Investors ‘Some investors specialize in making leans to businesses. Tn many cases, the investor(s) will require a panial ‘ownership of the basiness. Care shoold be taken in ‘dealing with private investors to see that your interests are property protected. Investors can sometimes be found in classified advertisements. US, Small Business Administration ‘The SBA’s basic Joan guarantee program is generally Used to Fund the varied long 4erm needs of small business, ‘The program is designed to promote small business formation and growth by guarantecing long-term loans to ‘qualified firms that cannot obtaining financing on reasonable terms through normal lending channels. 0 U.S. Smasi Businass ActministrationLoans are available for many business purposes, such #5 seal esate. expansion, working capital or inventary. Generally, SBA can guarantee up to $500,000 -- usually Tpetween 70 percent and 90 perceat of the Joan value - at an interest ue not to exceed 2.75 percent more than the prime lending cafe, Maturities are up to 10 years for ‘working capital and up to 25 years for fixed assets. Occasionally, SBA will est new loan products or seevices, Different loan programs may include reduced paperwork, shortened approval periods, or smatter Ioan amounts, Customers should contact their local SBA District Office to earn what specialized loan programs available in shels area, Fact sheets explaining the various loan programs that the SBA administers, including fixed lines of credit, are available from the SBA. Also available from the SBA or SCORE are brochures eotitled "Business Loans From The SBA” The Loan Proposal ‘When you approach Tender or investor for the purpose of obtiining funds for your business, you must have the means of telling your story in astraghforward and. convincing manner. The best way 1 do this is with a ‘writen foam proposal, presenting all the pertinent {information ina logical farmat. Although a well-done proposal requires a considerable uncont of work, the effort is usually worthwhile. It indicates to a prospective lender or investor that You thoroughly understand your business and its financial ‘demands. The proposal must be thorough, concise 270 neat It may be submited in longhand, but iis worth the money to have it typed. Cash flow charts may be submstted in writing, ‘The proposal should answer most of the questions that will be asked by a prospective lender and should present a convincing picture. Tel it like itis, being totally honest. Overstatements of facts and figures will not serve you well in the feng run and wll be challenged by an astute leader. If you cannot prepare this yourself, get help. It will pay off! Exhibit 3 provides an outline of a typical loan proposal. Exhibit 3 - Outline for a Loan Proposal m Cover Page A. Name, adress and telephone aursbet B. Nanse and file of principals} Amount oF loan investment) requested D. Purpase of the loan (investrent) E. Repayment terms ofthe loan Description and Surnmaary af the Business ‘Length of time the business has been operating ‘The business's historical trend “The naruce of the business Wha: does it do? ‘What is unique about your product line or service? ‘What or who is your marker? ‘The basinese’s competition, ‘The business's long-leea growth plan Trends in your induamry ‘Management ‘A. Your management experience B. Your menagement oun 1, Table of organization 2. Brief révor of key individuals and their espornibibues ‘Current staff or work force lve! and Fume needs 4. Bristing backop C, Your accountant and storey ‘The Loan (Investment) Request A. Justification ofthe loan B. Details ofthe loan request 1, Amoustnecded 2. How the finds will bo used 3, Collsteral available for a loan and it value 4. Repayment teams ofthe loan 5. Ability pay aloan Financial Data AL Financia! statements 1, For anexisling ousines, three years of Iestorical and any interim statements 2, Balance sheets 3. Profitand lors or income statement B, Projected cath How analysis fr a least the next 12 mouth, inluding loan (ewestimest) ©. Sources and amounts of any other loans or investments (0 Be pu into the business D, Personal financial statement Credit Information A. Buuks at which you mintain accounts BL Banks at which you have borrowed money CC. Trade suppliers D. Other creditors Miscellaneous incorporated, copy of atcles of necrporetion renting, copy of lease ‘Type end arrount of business insurance coverage ‘Aging of accounts receivable Copies of business and personal ax returns Rormpne> moORP US. Small Business Administration "GEE Saal ‘The importance of business planning cannot be ‘overemphasized. A business plan is an opecating ool, that forces you to take an objective view of your business, and provides the means 10 identify areas of strengths and ‘weaknesses. It pinpoints needs you might otherwise ‘overlook, spots problems before they arise acd points out ‘what must be done to make a profit and increase your ‘business. A business plan can help you avoid entering {nto a venture that may fail. Ifthe plan shows the business tobe marginal, the hours spent writing a plan will save ‘you the nigh cost of a business failuce, ‘A business plan + Clearly tales both the short- and long-zange objectives of te business *+ Provides the direction or pln for achieving these objectives. + Provides financial forecasts based on yout ‘estimates ofthe future and your business. experince, * Provides budget guidetines, including projected cash flow analysis and income statements © Gives a break-even analysis af your business. ++ Helps determine the acnount and kirds of financing best for your business. » Gives banks, investors and suppliers useful information they need to make fast and accurate decisions about your business. + Farces you to think thcough every aspect of your business and recognize opportunities for growth and profit. + Provides financial information so that ve pas: cen be compared tothe present al fone Is not possibic in this Handbook to present an example ‘of 3 complezed business plan. Exhibit 4 contains an outline listing the contents ofthe plan, Remember, a business planis a dynamic, not z suai tool After itis prepared t must be used eiten. tts Meni, nocrigid, and should te altered as conditions change. Most inponant is thatthe ownes(s}/manager(s) prepare the report. 1f you have trouble understanding how to write a pan, be ‘quick (o get help. SCORE caa be of great assistance. ‘Also, an accountant car. help im preparing the financial reports. However, only you can set the objectives of the dusiness—only you can decide where you want the. Dusiness to po and what you want it zo be. Do it! | RECORD KEEPING | ss Experience has cleasly demonstrated that fora person about to start a business, an adequate record keeping system will increase the chance of survival and reduce the ‘rebability of failure, Similarly, forthe established business, experience bas shown that 2 good record-kecping system increases the chances of remaining in business and of earning larger profits, How’ Because ‘accounting records can furnish the following ely information: Amount of business done ia cash and credit ‘Amount of business tied up in eceivables. + Asmount of collections ard losses from eredit sales. + Aging of accounts recebvable and amount of credit given to delinquent accounts. ‘Amount ef cash on hand and in the bank, ‘¢ Whether business records agree with hank, statements, + Amount awed to creditors and suppliers. + Gross margin. 4 Tolal expenses. + Amountof weekly payal + Adequacy of payroll recor for withholding, ct + Payment of taxes and deposis of withholding. + Net profit eamred and axes owed + Which proctor service makes profit. * Which produc or service loses money. Amount of money invested in inventory. 2 US. Small Business AdministrationExhibit 4 - Outline of the Business Plan Cover Shect—Contains name of te business, ramet oF (@. Application wnd effect of fosn or personal funds principals, adévess and phone sustber of business, name and ‘iless of person who wrote the plan ‘Statement of Purpost—Aa operating and poliey guide for your Dusiness funds ae needed, stele how Uiey willbe used and wnt effec hese funds wil have on the business. ‘Table of Contents A, Deveripion of de business 1, Product sold, services offered 2. Capital equipment and value 1. How much is needed 2, What for —nventory, equipment, renovations, te 3, How funds will help business 4. What aypens if fads are not available in fl) HL Objectives of business and plans w abhieve cher 1. Listobjctives for each par of your business 2. Describe your plan ip achieve euch objective TL. Summary—Summarize all thoyghte wed dens shout the business 50 at Chey make sense to you and readers Port —Financtat Date A. Sources and application of fading —A resttement of B. arkee | er say your potcter ic Pare l-G, Shows up csh flow projections 2. Who needs ic B. Capital equipment jist—but list depreciable assew on 3 Siusof te muket income saucent 4. Growth potential Balance sheet—Shows ates, Linbilites net worth ©. Location of business slagiven tine 1 Physiol features of site 2. Whether itis leased on ovned D. Break-evenanalysis—The sale or inoame poit at 3. Renovations needed “whieh the company breaks even 4. Desctipon of neightericod 5. toning reactions, any E. Tnenme projections (Profit an loss saements) & Other businesses in the tea 1 Thre yer nny 1. Acvantages an disadvantages ofthe loenton 2. Fn yoo detiled by months 8. Whether location snecessry and, 40, 4. Second and tind years detail by quarters ect on opesting cose 4. Noves of explanation D. Competition Fo Cash flow projections: 1. Names and uddesses of competiors 1 Fiat yer detailed by months 2. Theishare of marker 42. Second and third year cetailed by guaters 3. Wha you have thas your competitors do mot 4. Notes of explanation 4. cae effets ofeomptitor 5. Cempirison of your site nsde and ou to G.Deviaion analysi—Compaes neal income eed competion expense projevted income and expenses ob a ‘rort-ig-month bats, SpoW srengle and weaknesses. ‘E. Mamagement {Your background aad experience Historia! fnancia repo for exiting business 2. Experience of management employees 1, Balance sheets for past three years 3. Analysis of sbength and weaknesses of management 2. Team statement for past he yes isslading your om 3. Taxeetims 4. Neds or he futce and pha ore 5. Job descriptions and sining program Pure Supporting Documents Trades personal risumés, radi report, job deseo, F,esaael ceonae, gal documens, eters of irtest and anything 1. Number of employees an experience 2. Swrengths and weakresses 3. Skillset for Eanie 4. Plans ro hite ang trining programs nas todo with the plan US. Small Business Administration iRecords provice a wemendeus amount of information, ‘Most importants thai Une system be + Simple w use. + Easy io undersand. Reliabie. + Accurne, + Consistent, + Able to give information ona timely bass ‘The following information must be rocorded: + Cash eceips + Cash disbursements (expenditure) * Sales. + Purchases. + Equipment + Toventory + Aecoums receivable (amount customers ove). “+ Accounts payable (what business ome5). From the record keeping system, the owner/manager must dbotermine the following information: ay + Cash sales and cash receipis. + Cash on hand, + Bank balance of business. + Monies paid ou:—both cash and check + Accounis receivable, + Accounts payable, + Payroll in derail + Taxes—sales, social security, withholding, et. * All journal entries posted as like elements to general ledger. * Cash flow statement, «Profit and loss statement. ' Balance sheet. ‘© Reconciliation of bank statement with awn books. Peity cash balance, All federal wxes deposited and withhoiding and sales taxes paid, * Accounts receivable aged to 30, 60 and 90 days. ‘+ Inventory worked to remove dead stock and order Every business needs controls. Ifyou do not control the ‘business, it will control you. Adequate record keeping provides infomation for preparation of the suaements that provide the control. ‘Thore are five control statements thal give a chear picture of your business: ‘+ Cash flow sheet—Shows the cash in compared to the cash out by subtracting disbursements from receipts. © Income statement—Shows total sales and receipts, cast of sales, gross margin, expenses and ‘et profi, all expressed in percentage of sales. Balance sheet—Shows assets, liabilities anu net ‘worth of the business. ** Break-even anaiysis~-Shows at what level of sales the business breaks even, Break even analysis is based on gross margin, * Deviation anafysis—Compares actual pecfocmance to projected performance. These are ibe early warning systems, the problem inicarors and the solution indicators I there isto be only 4 single statement available monthly, it should be the cash flow ststoment, because this will show haw well cash is ‘managed. Obviously, cash in must be greater than cash out Before you open the Geor of a new business, be certain a _good record-keeping sysiem is in place. If you do not understand the need fer this, it indicates you da net have ‘coough managerial know-how a run a business, If possible, do the record keeping yourself. I not, hire a part-time bookkecper, use # business service or public accountant. SCORE car help you set upa system, In any case, be sure—absolutely sure—that you understand what records are requived for your business, If system is designed by someone else, understand the system, TRS Publication 583 is he?pful forthe beginner. 4 US. Smal! Business AdministrationSuccessful business owners know that the greatest ‘opportunity for success and growth comes through quality of service and customer satisfaction, However, the service must be priced properly or there will be n0 profi. ‘Many small businesses do what they consider a good ‘volume of business, bat do not make any money, Why? ‘Because of improperly priced services or products. Some ‘make a profit on certain services, Jose money an athers ‘and do not know which is which. Remember, the right to establish price is yours—-100 percent yours. Types of Costs For the purposes of this section, costs are defined as 4 Fixed coste-—Costs that remain the same in any line period despite changes in business activity. ‘These incl et, irsurance, utilities, office supplies, salaries, dopeeciation, legal services, ‘accounting and propery taxes. Those expenses ace usually callod overhead. + Variable costr—Costs that usually vary in ‘proportion with business activity. These include ‘materials used in manufacturing, goods purchased for resale, labor and commissions. In service ‘business, labor may not be variable Calculating the Cost of a Service ‘A simpte, casy-toamderstand method of calculating the cost of a service is by basing the cost on billable hours. Because services must be provided by people, begin by determining the number of hours available for billang in a year, Then calculate the break-even point by dividing the ‘overhead and labor charges by the billable hours and adding the cost of any materials used. Your desired profit is then added to the break-even point. Two examples are shown below, Example t ‘Two people experienced at bookkeeping open a business together. They estimate their overicad expenses as shown in Table 2. ‘The 1wo entrepreneurs decide they cach want a salary of $25,000. In this case, the salary is actually an overhead ‘expense, but we will iret it separarsly because the principals decide they want :o make a profit of 20 percent ‘on their salaries but only a 10 percent profit on their ‘overhead. These expenses ate sel oul below in Table 3, — GER nacaieciaa SERVICES PROFITAB! ‘Table 2 - Estimated overhead expenses Expense Amount per year 59.600 Utilities 1.800 ‘Telephone 1,200 Office supplies 1.200 Insurance 500, Depreciation 2.500 Advertsing 2.000 Miscellaneous 4,500 Total 520400 Table 3— Estimated total revenues required Expense Amount per year ‘Owners salaries $350,000 Profit on salaries (20%) 10,000 Overhead . 20400 Profit on overhead (105%) 2.010 Total 582.440 ‘The number of working days per year is 260 (5? weeks x S days), Subtracting holidays, vacations and sick days, the actual number of work days tou 230, Two people ‘working 8 hours per day results in 3,680 heurs (230 x 2x 8 = 3,680). However, the bookkeepers estimate ‘20 percent of these hous (736) will not be spent working for clients, Therefore, the billable hours fe this company total 2.944. ‘To deiermine what rate to charge, the bookkeepers divide the desired revenue {$82,440} by the number of billable fhours (2,944), resulting in an hourly rate of $28.00, Profit isthen celcvlated by subtracting total overhead and salaries from the proposed revenue {$82,440 — $70,400 = $12,040). This isthe profit \o be realized, assuming the billable hours figure is realistic foe the first year of operation, Example 2 WA Repair Service employs ten repair technicians, who are paid $18,000 each, Social Security lax, unemployment tax, workers’ compensation insurance, health insurance and retirement benefits cost an additional 85.400 cach, for 2 total cost of $23,400. Because there are ten technicians, the yearly labor change is $234,000. US, Small Business Administraton 7DWA Repair Service's overhead expenses are listed in Table 4, Table 4 -DWA repair service's overhead expenses Expense Amount per year Sclaries (including owner) "$60,000 Payroll uxes and costs 3,700 Insurance 13,000 Uiilies 2,600 Reat 10,000 ‘Telephone 1,200 Depreciation 5.000 Miscellaneous 2,500) Total 358,000 ‘To break even, DWA Repair must have tal revenue of $234,000 (labor) plus $98,000 (overhead) = $332,000. ‘Alt of itmast come from te income ofthe repate sereice based onthe bout rate charged. ‘The owner of the business bas calculated the billable hours as fotiows: Work days per year = 52 weeks x 5 days = 260 days, Subtracting 15 vacation days, T sick days and 8 holidays leaves 230 work days. Work hours = 250 work days x 8 hours = 1,840 per year for cach repair technician. However, from experience, the owner knows thet he ‘cannot keep his erew working eight hours per day as there 4s Jost time between jobs. He deducts 10 percent of the hours as nonbillabte, leaving 1,840 - 184 = 1,656 billable hours per technician. Because there art 10 technicians, the toxal billable hours = 1,656 x 10 = 16,560 por year. ‘To determine the hourly labor cost, the owner divides the Tabor cost per year ($234,000) by the billable hours (16,560). The result is $14.13 per ous. To find wtal cost, overtiead must be added, Toul ‘overhead per year is $98,000, When divided by billable labor hours of 16,560, overhead equals $5.92 per ou, Thus, the total hourly cost of labor plus overhead is S14.13 + $5.92 = $2065, ‘The owner knows hat ifhe charges only the hourly rete based on actual cost, he will merely break even, Tn order tw make a profit so that e ean reduce debts, buy new ‘equipment, provide working capital and provide a return ‘on investment, dhe owner decides 10 a68 25 percent on his labor, and 30 percent on his overhead, as shorn in Table 5. Table 5 - Calculation of final hourly rate Labor cost per hour + S413 Profit on tabor (25%) 353 (Overtead onst per hour Overhead profit 30%} Toiat ‘The awner decides to charge $25.50 per hour, This hourly rate, muliiplied by the billable hours of 16,560, resulis in «an income of $422,280 00 per year. Thus, the income. ($422,280) minus the expenses ($332,000) equals profit of $90,289. Each year this calculation must be repeated to include any changes in labor of overhead, any materials are used in the repairs, they must be figured imto the cost per job. A profit percentage is also ‘added to the materials charge. ‘Remember, the charge for a service equals materials plus labor plus overhcac, with a profit built imto each component. aaa Ue Ear eg Ae {In setting prices, the objective is ta maximize profit, Profit has just three ingredients: cost, selling price and sales volume. In this section we are concerned with selling price, which has about the same elements for all lypes of businesses. For example, it manufacturing, the clements of the selling price are direct costs, ‘manufacturing overhead, nonmanufaccuring overhead and planned profit, In.a service business, the elements ere ‘matetials and supplies, labor and operating expenses, planned profit end corapettion, (See “Pricing Services Profiiably,” page 15.) In a retail business, the elements of rice are costs of goods sold, overhead, sales volume, planned profit and, often, competition 6 U.S, Small Business AdministstionTypes of Costs Jn the retail business, there are two types of costs: the cast of acquising the goods, called cost of goods, and the cost ‘of operating the business, called operating expenses, Cost of Goods (Vartable Cost) Cost of goods is known as a variable cost or expense ‘because it varies depending upon the amount of goods purchased for resale and the price of the goods. Cost of goods includes the price paid for goods, freight charges, impor dies, handling charges and any commissions. Operating Expenses (Fixed Cost} Operating expenses are a fixed cost because they usually do not vary with the volume of business, Operating expenses include wages, management salaries, rent, uiives, office supplies, insurance and any other costs ausibuted to the operation of the business, Planned Profit Planned profit is whatever the owner/manager calculates lhe business will generate, Usuaily, relum on ommer's investment, frits of labor, plans for expansion or selocation, retam to stockholders, demand for the product and competition are considered when calculating the amousi of planned profi. Competition 1 seting prices, small businesses stould consider prices ‘harged by competitors fer similar ar comparable items, A srcall business should not iry to compete pricewise ~ith lage stores, discount houses of supermarkets. type of competitor can charge less hecause of buying power, Pricing should be based on the quality oF type oF service offered, as customers will ey higher prices for ‘merchandise o obtain the services they want, Pricing Below Competition Beating the competitor's price is effective only if really increases sales, This strategy reduces the profit margin, Consequently, cast of goods and/or operating expenses must be reduced and inventory must be closely ccontrolicd; the product line must be limited to fast moving items, and services must be timited or eliminated, Pricing below competitors often backfires because every ‘cost component must be constantly monitored and «adjusted, Competitors can retaliate by matching the lower ‘prices, at which point both businesses lose. Pricing Above Competitors ‘This sirategy depends on whether non-price ‘considerations are imponant enough to customers 19 ustify higher prices. These considerations include specialized services (such as delivery, product knowledge, exclusive location, brand or designer names}, satisfaction in handling complains, in-home. demonstrations and 30 on, Markdowns A markdown isa reduction in the price of any item brought about by overbuying, overstoeking seasonal merchandise, misjudging customer response, poor personal selling or competition. This technique is used to avoid being left with dated merchandise shat will be dificult to sel. Tn setting a markdown price, the original cost of the merchandise should be recovered if tall possible. [fde selling price originally was high enough, a simall profit is possible Price Lining ‘This is a marketing strategy based strictly on price, A. specific portion of the Buying public is targeted by ‘carrying products in a specific price range. For example, ‘etal sxre carries an exclusive line of women’s ‘ndesgarments or an expensive designer perfume line, Price lining is only seccessful if there i litle or no competition. [1 works 0 the benefit ef the reaifer because it limits the merchandise line and makes inventory and baying casier, Its also easier for the customer to select ‘merchandise, 50 that fewer salespeople may he needed. Markup One technique of establishing price is to mark up goods sold by adding a percentage to the total cost of the goods, For example, a retailer purchases shoes at $25 per pair ‘and marks them up 60 percent for resale. Cast of shoes per pair = $25 Marup percentage Oe Markup amount per pair = $15 Selling price per pair = S40. ‘The 60 percem markup must caver all operating expenses, including the owner's salary and profit, ‘A given markup is satisfactory depending on the sales volume, When beginning a business, itis difficult to determine how much goods must be marked up because he new business has no history of sales on which ta base US. Small Business Administration ”Iuture safes projections. An experienced reuailer usually can use markyp successfully, particularly if he or she has histosical information regarding the ovement of ‘merchandise. Suppliers often suggest a retail price, which makes it easy forthe resales. If there is a competitor selling the same o comparable merchandise, check the competitor's retail price, It may dictate your price. Break-Even Analysis ‘A break-even analysis can be used by a mew or old manufacturing or etail business. It indicales the amount of revenue at which a business will neither lose nor make money. For a retail business, the break-even point is ‘when sales equal the cast af goods plus operating, expenses, ar SHFOWE where $= sales in dollars FC x fixed costs er aperating expenses YC = variable costs of cost of goods, From a sirict accounting standpoint, cost of goods cannot ‘be determined until an inventory has been taken, because cost of goods is determined as follows: Inveniory at beginning of a period + Purchases during the period — Inventory at end of period = Cost of goods sold ‘Thus, the break-even analysis involves a variation ia the ‘reak-even formula because the total cost of goods is not known. Fist, gross profit (also known as the gross ‘margin ex contributing margin) on sales is determined as follows: Cost of sales — cost of goods = gross profit “The break-even point is chen calculated as FC (operating expenses) + GM (gross margin) Earlier, an example of a retailer buying shoes for $25 a pair and selling them for S40 a pair was used. The gross margin on each pair of shoes sold was Selling price = $40.00 or 100% (Cost of shoes = $25,000" 62.5% ‘Gross margin= $15.000r 37.5% [Note that the gross margin and cost of goods (variable anit cost) are expressed as percentages of the sales price ‘Let's assume the shoe retailer has operaling expenses (fixed costs) of $75,000 per year. The break-even point is FC (875,000) + GM (37.5%) = $200,000 in sales. ‘Sales of $200,000 mean the retailer must sell 3,000 pairs ‘of shoes at $40 per pair to break even. Assume the retailer ‘cannot sell 5,000 pairs of shoes. To break even, he must ‘aise his price, which will raise his gross margin. The ‘question is how much the retailer will have wo raise his price to break even, Assume the retziler determines thet he can sell the shoes for $50 8 pair. ‘Selling price = $50.00 os 100% ~ Costishoes) = $25.00 or 0% ‘Gross margin = $25.00 or S0% ‘With operating expenses of $75,000, the sales volume to break even is FC ($75,000) + GM (50%) = $150,000 oF sales Ata price of $50 per pair, the retailer now has to sell 3,000 pairs of shoes to break even. The retailer is cennfident he can sell this volume, but he. will not make & ‘profit selling at $50 6 pair. He world like to realize & ‘Profit of 10 percent on his operating or fixed costs ($75,000 x 10% = $7,500). To calculate the volume of sales required to earn this proit, he adds the profit to the Fixed costs. If he hokis the price at $50 fora gross margin, of 50 percent, the sales needed to realize this profit are FC + profit (575,000 + $7,500) + GM (50%) = $165,000 in sales ‘This level of sales will cover the variable expenses (cost ‘of goods), the fixed expenses (operating expenses) and a profit of $7,500. To generate $165,000 in sales, he emust sell 3,300 pairs of shoes at $50 per pair. Because the retiter has no competition, he is confident he caresell thie volume of merchandise and can also raise ‘the unit price of the shoes. He decides to do a calculation using a gross margin af 55 percent. FC + profit ($75,000 + $7,500) + GM (55%) = $150,000 in sales ‘The unit selling price ot price per pair of shoes at 55 percent gross margin is determined by dividing the ‘cost by the percent of variable costs. VC = 100%- GM% = 100% - 55% = 45% 18 U8. Smal! Business Administration‘Unit cost of shoes ($25) + ¥O% (45) "= $55.56 oF 856 selling price Asacheck Unit selling price = 100% © $56 ~ Vaiadlecos = 454= 95. ‘Gross margin 55% = $31 Let us determine if $150,000 of sales at a gross margin of ‘55 percent will provide a profit of $7,500. Total sales = $150,0000r 100% - Costof sales = 67.5007 45% Gross margin = 82,500 or 55% ~ Fixedeous = 75,000 Profit = $7,500 fa business manager calculates the gross margin for all ‘merchandise sold, the price structure that will generate a level of revenue to purchase goods, pay operating, expenses and make a profit can be determined. ‘The gross margin percentage can be used 88 a monitor of the salesipurchasing area of the business. The gross rmargin calculation allows the manager to buy goods that can be soldat or higher than the desired margin. Pricing policy should be based on gross margin, fan item of merchandise has a low sales volume, it should have as high a gross margin as possible or else it [No mutter how wonderful or unique your product or service i, nothing sels tse, Potential customers must be told about your product or service and how they can purchase it, Informing potential customers about your product, service cor business is called advertising, derived from the Latin “ad” meaning "woward,” and “verre” meaning "to tom.” Togette, the meaning is totum voward a product or business, Advertising is a paid communication, the purpose of which i to impam information, develop altitudes and induce favorable action for the advertiser, The means of ‘communication can be as humble as a matchbook, as traditional asa bazter’s pole or as elaborate.a5 a celebrity-packed commercial. Remember the beer ‘commercials with all the athletes atthe har? will not be proftabi, Ifa business does a high volume of, sales, it may be possibic to have a pricing policy based on A Tower gross margin, subject to calculation In review, the break-even point is the level of sales that ‘will jst cover fixed phus variable expenses. By determining the gross margin for each item of goods sold, the level of sales needed to break even can be determined asfollows: Fixed cost + gross margin = break-even sales, By adding planned profit to fixed costs, the level of sales to make the planned profitcan be determined. To Group life and heath «© Fidelity and surety. ‘© Workers’ compensation. ‘Before purchasing insurance, find out which types are required, how you can reduce the cost of coverage and ‘which risks you can afford to cover yourself, Also, you aust ++ Decide which kind of risk orotection wall work best and be most economical for you. * Cover your largest loss exposure first the less severe as your budget permits. ‘+ Make proper use of deductibles, They save ‘premium dollars you may need elsewhere. + Review your insurance coverage and costs periodically with your ageat, Always discuss expansion or change of location ‘vith your agent. + Familiarize yourself with insurance terms and. Drovisiens 50 you know exactly what is covered and what itcosis. = Be sure the coverage you buy is adequale ta cover the value of the property insured. ‘Usually, the life savings of a small business owner are ‘invested in the business and often homes are used 10 secure notes. What happens when the owner dies? Does the business close? Does the family of the owner hav: 1 ‘stand by and watch savings and other assets go down the dain? ‘You can proiet both your business and your fami with ‘basiness Hie insurance, Consulk your agent so that a ‘bosiness life insurance poticy is tailored wo ft the needs of a U.S. Small Business Administrationyour family and your business. A suitable business life ‘insurance program can ‘+ Ensure immediate funds to meet axes, debts and administrative expenses, ‘Provide income for heirs. ‘© Equitably distribute the proporty vale tn heirs. ‘+ Enable your executor or administrator o dispose cof your business to the best advantage if your family is not king over. ‘+ Pur your fomily on a sound financial basis if the family is assuming the operation of the business. * Stabilize the credit of te business. '* Help maintain good employee relations by eliminating uncerrainties and hazards. ‘lf the business is a partnership, provide a ‘prearranged plan for the orderly and equitable dissolution of the partnership and the opportunity for surviving parmers to buy out the heirs, ‘+ Provide funds to replace a key cinployee oF ain another ifthe key employee leaves, becomes ill or dies, This is called “Key Employee” insurance, Insurance is one arca of your business where professional fhelp is strongly recommended to obtain proper coverage at the best price. Help is readily available from local insurance agemts and brokers, the best choice being one ‘who writes insurance for other small businesses. ‘One way to determine which insurance agent is best For ‘yous to ask other small business owners whom they use ‘and what kind of service they receive, Also, your hunker, ‘accountant or attorney may be able w recommend an. ‘agent or broker. (Eta aes Image ‘Every reail end retail-service business has an image, hich can be controled by the operator. People’s impression of a store, office, showroom, beanry shop is based initially on the appearance ofthe premises, both inside and cut, and then by the type of merchandise and services offered. Therefore, each business operator must decide what image he or she wamts and then take steps to develop it Ceeating the proper image and environment is particulary ‘raportant to certain types of businesses and not as critical fo others, For example, a junk yard may not be very attractive; but then is customers do not expect itto be. However, most business should create an atmosphere that corresponds to their product line or seevice. For example, people do not expect carpet in hardware stores; but they ‘do expect clean, uncluttered sisles and easily accessed displays. Ina store selling expensive clothing, people will ‘expect carpoting and papered walls. There is no doubt that carpet leaves a diffezent impression than vinyl dle or {inoteum and costs moro ta install and maintain. tn this case, the extra cost may be worth ft. Window Displays A neat, eye-catching window display is an effective way to stop pedestrian waffic and entice people ws enter the promises, It takes only (wo to four seconds to passa six- ‘or cight-foot window. Therefore te display not only has to be eye catching, but also nmst be well lighted day and night. (Good daytime lighting avoids shadows that dull a display.) ‘Change window displays periodically and keep windows clean, Window displays used for community projects ‘often create good will. Art galleries or individual ‘collects may lend interesting objects around which 1c build display. Parking Arees and Sidewalks, Keep parking areas and walkways clean and lighted at all times. If your regional climate brings harsh winter ‘weather, be sure snow, and particularly ice, is removed 1 ensure customer safety. Dirty areas creaue an unfavorebie impression and often result in unfavorable comments, Decor Decor is par: ofthe image. Well-mainiained building exteriors make customers want to enter. Once inside, the interior decor must be conducive to customer buying. ‘Clean windows, floors, counters and aisles, attractively painted of papered walls and good lighting are a must. ‘Well-planned aisles help customers find and look at merchandise. Gaudy decor reduces customer interest. The ‘decor should make customers feet comforuble. The point isto let the merchandise be the attraction, not the decor. US. Small Business Administration 2Customer Relations Customers not only sustain a business but help it to expand. How a customer is greeted and weated can build ‘or destray customer relations, The old adage thatthe. customer ig always right sil applies. Courtesy is business byword, Customers who feel they ‘were nol treated properly, for whatever reason, usually do ‘not return and have only derogatory comments about tht ‘ousiness. As pointed out in the sectien on advertising, ‘word of mouth advertising is not only the least expensive but also one of the most effective types of promotion, All employees should be constanlly reminded of the need for courtesy. Keep s notebook near the cash register. Jot down customer requests and suggestions for products and services. Castomers are great and inexpensive source of information not only aboot your business but about your ‘competitors as well, Customers can tell you much about their buying habits and help you detect tends. Ask ‘customers what zbey like, want, need and read, Without ‘customers, there is no business. Credit Cards ‘Credit cards are a service 10 customers at the expense of the business, However, credit cards do provide instant ‘cash at no risk to the business. Often, creditcard terms ‘can be negotiated withthe iseuing bark. Card cormpanies such as American Express can usually be approached through chambers of commerce or national trade associations if the business is & member. Some small businesses may want to issue charge cards or ‘charge accounts to special customers, Needless 10 say, ‘care must be taken if this policy is adopted, Markdowns ‘Markdowns on certain lems reduce profit margins but usually ate an excelleat way 10 sell ursakable or ‘end-ol-season goods. Markdowas, if properly done, clear ‘out mezchandise quickly, dheveby increasing cash low and reducing inventory. Loss Leaders ‘Lose Feaders are items sold ata lower price wo auract ‘people wha will buy ether regularly prived items or ‘become regular customers. Loss leaders should have a ower wholesale price, look more expensive, sell at other lores al a higher price and he readity avaitable from the supplier. Loss leaders are more effective as a strategy when they are associated with another item at regular price and both jnems are sold together. An example isa shin and tie, ‘with the tie being the loss leader. ‘Sometimes loss leaders da not work, With experience, the ‘successfi leader will be selecied and ofien can be used ‘over and over ogain, Pricing Policy Pricing may depend on the following: ‘+ Location ofthe business, «Physical appearance of the premises. ‘Purchase of manufacturer's close outs, + Volume of sales Pricing muss take into account fixed or operating costs, ‘owner and manager salaries, variable costs (cost of goods) and profit. Buying practices affect the cost of goods. Auention must be given to quality as well as the quantity ‘of goods purchased. Utilities, rent, services, salaries, ‘employee benefits, etc, affect fined costs, Unless prices ace changed accordingly, increases in either variable or fixed oosts will decrease profit. Often, competition dictates pricing, Therefore, competitors” pricing must be constantly monitored. As pointed out in the section on pricing products, apricing policy must be examined and reviewed frequently to be cemain the desired profit level is maintained, Profit and {oss or income statements are most helpful Leases Landlords can be difficult; remember they are trying (o ‘make a profit, to0. Cordial relationships make it easier to get improvements 10 the premises and to negotiate late rent payments, A long-range lease is usually better. Ifa business owner (or operator is inexperienced. with leases, the service of ant atlerney is essential, Protecting Against Crime To limit shoplifting, locate the cash register and the. telephone near ora the fmt Soor. This reduces the hance of people walking out without paying. Also, offer te hotd parcels a the register, Dot be sure 10 teat them wit care, sealing them inthe presence ofthe customer, ‘Tre business is liable if anything is missing. 6 US. Smal Business AdministrationIf your business is located in a shopping center or mall, contact other small businesses and set up a system ta let each other if a customer tres 10 passa bad check or stal, ‘With a phone alert system a description of the person in ‘question is quickly circulated to other businesses inthe center or mall, a8 well as to law enforcement authorities. Compettiors ‘Always have something constructive tp say about ‘competitors. Ifyou are out ofan item or do mot cary it, zecommend a siote that docs camry it, Customers sppreciote this and will usually retum to your store. Watch competitors’ advertising by visiting them or sending someone to check displays, windows and prices. ‘Ask salespeople who call on you bow your competitors ate selling their eres. Employees ‘Good employees produce more sales and require less ‘raining and supervision. Poor employees can ruin a ‘business. Develop 2 raining program for new and old ‘employees and regularly review thels performance with them individually and privately. Train employees to treat castomers exactly as you would. ‘Explain the buying system w employees and try w svoive them. The more involved employees are, the more interest ihey take and the better they work. Listen to employees and ask them for suggestions. Make employees your eyes and ears. Retired persons offer small businesses an opportunity 1 agecexperienced help on a part- of full-time basis. They may teach you and other employees what they have learned over the years. Retirces usually are very loyat and hard workers. ‘Suppliers Suppliers, manufacturers, distributors and their respective. salespeople can become amportant adjuncts to a small business. They cam alert you to tends, hot items, competitive activity, closeouts, special volume prices, delayed payment terms, et. ‘Most important, get to know the credit manager of your supplier. If you need extra time w pay, exis credit or special terms his isthe persen to cantact. The credit manager can be & valuable ally wo your business. For special promotions, ask manufacturers snd suppliers if they have a program to contribute wo advertising costs. ‘The way to leam about all the services a supplier offers is to spend time withthe supplier and ask questions. Re sure you know the availability of every item uurchased and how tang it wil take to get to your store. ‘This will help you place orders and keop you from runaig out of an item, EMPLOYEES AND iNDEPENDENT CONTRACTORS Classes of Employees For federal and state tax purposes, small business owners and operators must know who is an employer and who is ‘not, and what their classification is, Employees may be classified as common law or statutory. CommonLaw Employees very individual who performs services that are subject 10 ‘he will and conizal ef an emplayer as to both what isto ‘be done and how itis to be done isa common-law ‘employee, Two of the emul characteristics of an employer-employee relationship are that the employer has the right to fire an employee and the employer supplies ‘he tools an the place wo work, Employers must withheld federal income tax, Social Secutity wax and, where required, state and local income «ax from common-aw employees. Also, employers must pay their share of Social Security and federal and state unemployment tax for such employees, ‘Statutory Employees In many states, s statutory employes is one who works for aan employer in any one of the following four categories: 1. Adriver who distributes meat, vegetables. fruit bakery products or beverages (other ‘than milk), or who picks up and delivers laundry 0° dry cleaning, if ie driver is your agent or is paid on. commission, 2. A full-time insurance salesperson, 3. Am individual who works at home on materials or goods that you supply and Uhat U.S. Small Business Administration 2aust be returned to you or to person you name. You also Tursh tho specifications for the work to be done. 4. A (alltime traveling or local salesperson who ‘works on your behalf and obtains orders from wholesalers, retailers, contractors or operators Of hotels, restaurants or sitar establishments, The goods sold are ‘merchandise for resale or supplies for use in the buyer’s business. Business owners are not tequired to wichbokt federal and, ‘where applicable, state oF local income taxes from the ‘wages of statutory employees, However, individuals in any of the preceding four categories are employees for Social Secunty tax purposes if they meet all of the three following conditions: a. The service contract states or implies that almost all of the services arc to be performed. by them. 6, The investment in the facilities, other than those for transportation, used to perform the services is not substantially thal of such employee, &. The services are performed on a continuing basis, For federal unemployment tex purposes, the tm employee includes statutory empleyees in cauegories 1 ang 4 above who perform services for pay under conditions a through c independent Contractors Generally, people who are in business for themselves are. aot employees. These include physicians, attomeys, CPAs, construction contractors and others who offer theie services to the public However, whether suck people are employees or independent contractors depends on the facts in each ‘case, The general rule is that an individual isa independent contractor if the employer has the sight ws direct only the result of the work and not the means and methods of accomplishing the result, Under the heading of independent contractors, 160 calegerics of statutory nonemployees exist for the ‘purpose of federal employment taxes: real estate agents and ditect sellers. However two conditions must be met: 1, All zemunecation for their services relates directly to sales of output and nol to the ‘number of hours worked, 2. Their sorvices are performed under a writer, agreement that provides they will not be ‘ueated as employees for fedal tax purposes. ‘Another testis that when an independent contractor has sistant, they can be fred omly by the contactor. Also, if workers are free to take ether jobs at the same time they tare working for you, then they are generally regarded as independent contractors. ‘An employer does not have to withhold inceme tax or Social Security tax from the wages of independent contractors, mor does the employer have 10 pay the unemployment taxes or workers” compensation insurance. Because an employer who has hited sn indepentient contractor must fle form 1089-MISC with Le Inveenat Revenue Service and, where applicable, state and local government, te independent contractor must provide the employer with an employee identification oF a Social Security muenber. If he independen: contractor fils 10 provide this number, the employer may have 19 withhold 20 percent of the amount paid as income tax. Casual Labor ‘Many small businesses classify certain types of labor as ‘casual labor. In these cases, the employer does not withhold income taxes or Social Security tax, does not pay employment taxes and usually does rot cover the worker with any type of insurance, fone asks either the TRS or a state department of revere for a definition of casual labor none will be forthcoming. ‘This means thatthe IRS and outer agencies 20 not recognize the term and will not define it, Federal and. sae agencies reserve the right to judge eack case as 10 whether or not a worker isa casual employee. ‘The issue at hand is whether or not an employer must withhold income and Social Security tax, pay ‘unemployment 2xes and provide workers’ compensation insurance, In some cases, the IRS and other xing agencies may tecognize intermittent an¢ temporary labor, such as inthe following cases, Case Katic’s Catering has two foll-time employees. Katie ‘contracts fora job for which she needs extra help, $0 she hires a person to work for one day for SSO with no ‘withholdings of any hind, Sie does not intexd to hive this person on a regular basis, ey US. Smal! Business AdministrationCase 2 ‘Conwald Consizuction accepts a contract wo frame two houses and agrees to finish both houses within one month ‘Conwald does not have enough regular full-time ‘eraployees to accomplish this, so he hires two extra ‘carpenters at an agrced-upon wage of $300 per week for three weeks. At the end of the job, Conwald pays each carpenter $909, but does not withhold taxes, 6, However, because the wages were over $600 to cach person, Coawald roast obtain the Social Security number of each carpenter and, atthe cod of the yeas, submit a 1099-MISC to the IRS, appropriate local agencies and to the campenters. Casea ‘Russ’s Restaurant has occasional need for an extra ‘vareader during July and August, He hires a person 0 work one aight a week for eight weeks at 85 per night, ‘with no withholding. The sca wages paid are $360. Tn a this case, Russ does snot repost these wages because the. amount is less than S600, ‘According, to some state employment security las, the ‘workers in each of tee cases would be tegarded as employees and the employer would have to pay the state unemployment ia. (Often, employers abuse the classification of interminens or emporary help, Be aware that if te TRS decides the ‘employee is common law and the employes has not withhotd taxes, the employer is liable for all the wittholding, Social Security taxes and unemployment taxes. Both the suate and federal agencies frequently audit {income tax reports, during which the question of who is an ‘employee arises. If yhere is any question about who isan ‘employee, contac: the IRS or state department of revenue, [fthere is a question as to whether unemployment tax should be paid, contact the IRS and the siate department of ‘employment and taining. CEs) De neues) ‘Successful management of any business, large or small, is based on effective uilization of available resources, People are a primary resource, ané peop'e, including ‘manager, can make or break a business, ‘Managing a work force from 1 regulatory standpoint has become complicated because there are more than 100 rules anc regulations promulgated by focal, state and federal authorities that affect employees who make up the work force. Ibis imperative to seek guidance through this maze by contacting the appropriate government authority when necessary, Also complicating the management of workers is the new generation whose goals extend beyond ute basic ‘maintenance needs of wages and safe, clean working conditions. Many employees are looking fer challenge, incentive and opportunity ta learn, 10 be creative and to advance, Small businesses must design management ‘methods to meet the needs of employees as well as the basiness, ‘The work force payroll may be the greatest single expense inthe budget. This means employee selection, taining and supervision are of primary concern. ILis estimated tha: each umover of an emplayee costs 500 ‘umes the hourly wage; thus, retaining good employees is critical. Employee retention and productivity often ‘depend entirely on the ability of the person supervising the job. Ais essential to define the objectives of the work force and clearly plan the strategy 1 reach those abjectives at the outset. Once employces are on the job, reasonable, anuainable objectives should be set for them with their input. Iemptoyers are respected members ofthe tearm, they will have mote incentive to peeiorm al peak level Recrutting ‘Advertsing in the local newspaper is the most direct ‘method of tecruting employees. The mos productive sacthed is word.-of-miouth referral by a satisfied employee, Schools, trade associations and professional groups arc excellent sources for specialized needs. Asa sulk, itis wise to avoid employing relatives and ciose friends, as discipline problems often arise, If they tring special expertise, that may be another matter, ‘A prerequisite to hiring ary worker is a well-written, thoroughly thought-out job description, describing the duties and responsibilities of the job. Such a description makes it easier for the employee and supervisor to work together, Interviewing An interview is a two-way communication, during which the panuicipants find out about each other and assess US. Smal Business Administration 2%‘competence and compatibility. The interviewer must ‘guard against invading the Legal right 0 privacy of the ‘applicant, both on the application form and in direct questioning. “The primary concems of the interview are the job description, working conditions, standards of performance. and the applicant's ability to meet or exceed these standards. AI] these matters must be clearly understood and agreed upen before a final decision ta hires made, References must be checked, preferably by telephone, Wages and Working Conditions ‘Wages and working conditions are controlled to some deyrec by labor laws and, 0 a greater extent, by local practice. The Netianel Bureau of Labor Staisies can provide surveys of conditions in Toeal markers. Usually, itis wise 1 set wages atthe midpoist of current Practice to altow for incentive and future growth, Employee bexefits will add from 20 to 40 perceat to the ‘ost of the payroll Carefal thought must be given to benefits when planning anc budgeting, For businesses caperiencing peaks and valleys in work flow, thought should be given tothe use of temporary workers and agencies, Training ‘An employee may be considered on probation for an ‘agreed upon length of time—usually chee months. During this time, attention must he given to imegrating, the employee inlo the work force and bringing the ‘employee's performance up to standard, This is best accomplished by explaining and demonstrating the task, having the employee perform the task and then giving constructive correction and reiaforcement. Tine speat in proper taining will more than pay for itself in weeding ‘ut employers who lack the ability to perform or fit in. ‘Training fosters the success and high performance of thase retained. Supervision oth the supervisor and the employee have an interest in ‘the successful performance and stability of the work force. The essence of good empioyee relations isto treat all equally, and to be fair and consistent in maineaining discipline. Be factual and not subjective, Always let the employee know what is expected and whether cr not those expectations have been reached. Both correction and recognition should be given regularly to achieve a healthy and productive wark force. Terminating Employment ‘Whea an employment relationship is to end, itis expected that both the employer and employee will give the other adequate writen notice. If itis eceesary to temminace ‘employment, the employee should be given an honest explanation ofthe reason for termination. ‘When it is termination or cause, except in extraocdinary cincamstances, the employee should have been warmed previously, counseled and given the opportunity to meet the performance standards before the actul separation, ‘When the question of unfair treatment or diserinimation is raised, iis important to have a written record of the steps followed in disciplining the employee. ‘One caution: Because employee relations are so temuous and hedged by laws and other restrictions, it may be wise 10 seck expert advice when contempleting any critical action affecting an employee. SCORE can help direct you {to Le appropriate source of information. Gees IN SMALL BUSINESS ‘A question asked [requently by smal) business operauors is "Should I have a computer?” To answer this question, you frst must understand the advantages and disadvantages of sltematives to the computer and, second, rust know exact'y what is tobe accomplished swith a computer, In othex words, consider how much it will cost and what the benefits over a manual system will be, Finally, you should know who is going to operate and become proficient with the computer. Generally, a well-organized and well-staffed business ‘will benefit fom a compnter, particularly ifthe business das large amounts of detailed, repeiions information to be handled with speed and accuracy. Others who will Denefit are businesses with large fast tuming invemories and large customer fies, 30 US. Small Business Administrstion‘Small businesses just starting out without compmer skills should not consider a computer, nor should a business that does not have a good functioning manual system in ‘operation, What a Computer Can Do © Organize and store similarly constructed pisces of information, such as names and addresses of customers, supplies, employers, ete. > Rapidly retrieve a single pisce of information from afite or data base, eg. name, ZAP oode, date ‘of as purchase, amount owed. ++ Perform complicated computations quickly and accurately. ‘+ Print information quickly and accurately «Perform the same activity indefinitely and precisely, such as printing hundreds of form leurs, printing mailing labels, ete. ** Kecp tamsaction records, such as cash receipts, receivables ledger and a general ledger. ‘© Prepare statements and reports such as cash flow sheets, income statements, balance sheets and invenvory stars repors, ‘Areas @ Computer Can Improve © Accounts receivable. + Accounts payable. © Sales reconis. + Billing + Oxder entry. + Inventory records. «# Payrol. + Taxreponting. + Mass mailings. + Projections. «File management, What 8 Computer Cannot Do > Comecterrorsin an existing manual system, ‘+ Save money by eliminating employees. + Make business judgments or create log. + Solve poorly defined problems, + Define ot describe jobs that should te done. © Generate information that isnot in te system, © Operate itself Buying a Computer Before selecting a computer (hardware) and she programa (sottware), a prospective buyer should prepare 2 writien Statement thal includes the following information: ‘+ A description of the business. ‘© Present and anticipated number of customers. + real, number of transactions per day, Size of invéntory, if applicatie. © Invemory wrnever rete. © ‘Number of employees. ‘Reasons for buying the computer. Amount of money available, or affordable price range. +» Potential operaiors of the computer. ‘The purpose of this siatementis to pinpoint the prospective. ‘buyer's need for computerization and to provide concise information on these needs and resources iweach vendor approached. Going to more than one vendor is highly recommended 50 ‘you can compare prives and recommendaticrs. Also, ask ‘each vendor for te nantes and telephone numbers of ‘customers who have purchased a system, paricularly ‘those with needs similar lo yours. Contact several of these ‘customers and ask them if they are satisfied with the hardware, software, taining and service received from the vendar. Ask them how fong iL ook until the computer system was operational, Be sure the vendo has the staff to provide training, answer yours questions while you are serting up, solve ‘problems and provide repair service. Visit the vendor's Uaining facilities. Ask how charges for taining. -A-compuler will not operate itself. Ik must be fed, rmurtured and massaged in order io get resus, Emering data tes time, Iti important to realize that if your record keeping system is incomplete or sloppy. your computer data will be the same, Time and money can be wasted creating daa that will not be usec, Use good judgment in selecting information to be entered and processed. Software has been developed for specific types of businesses. Be sure your vendor is knowledgeable about available software and selects the one best suited 10 your US. Small Business Administration aparticular business. Experience indica thatthe computer applications most beneficial 1 a small business are accounts payable, order entry, accounts receivable, invontory control anc! general ledger. Geuiing a computer into operation initially requires the {full and total involvement of te ownez/manager, which luanstates into many cxtra and sometimes frustrating hhours. Meanwhile, the regular business functions must be ‘continued. If an employce is to operate the computer, the ‘employee will also have to devote extra hours, a the expense of the owner. FRANCHISES Franchising has a number of appealing features for ‘prospective business owners, Primarily, the risks of ‘opening a business are reduced because of easy access 10 an eswzblished product and a proven method ef marketing, Franchising has existed in one form or another for over a ‘century; in recent years enormous growth has occurted in he number of franchises, Industries relying on franchised business to distribute their products and services touch every aspect of life, from automobile sales and real estate to fast foods and tax preparation. ‘As a matter of fact, franchises have the highest success rave of any type of business star-np, which adds to their appeal, However, buying a franchise does not in any way ensare instant success; unless you are prepared for total commitment of time, energy and financial resources, iis net for you. Definition A franchise isa legal and commercial relationship between the owner of a trademark, service mark, trade. ‘name or advertising symbol and an individual or group seeking the right to use that identification in a business, ‘The franchise governs the method for conducting the business between the rve parties. Jn ts simplost form, a franchisor owns the xight to a name ‘or trademark ane sells that right wo a franchisee, This is ‘known as productlirade marae franckising, In the more ‘complex form, business format franchising, a broader, “ongoing relationship exists betwen the parties. The frarehisor provides a full range of services, including site selection, raining, product supply, marketing plans ant sometimes financing. Generally, a franchisee sells goods ‘or services supplied by the franchisor or sells goods or services that meet the franchisor's quality standards, ‘Computers do not save money by eliminating employees. Rather, compulcrs facilitate and complement employees” work by performing certain functions rapidly and cfficienlly. This may be of great advantage in cffecting “other saviegs, ake business owner/manager has his fingers an the pulse of his business, a computer may not be needed. 19 any even, the cost, efficiency and adequacy of a manual system showld be evaluated before you consider buying 8 computer. Advantages Franchising offers quick access to an established and well-proven method of marketing, which reduces the risk of opening a business, ‘© The franchisee purchases, along with the Uuademark, the experience and expense af the franchiser's organization ‘+The franchisee’s standing with local financial insulutions is strengthened, ‘© Branchisors offer taining and management assistance. ‘© The franchisor offers experience in facility design, layouts, displays, fitures, marketing and advertising. Disadvantages ++ Franchisors have required, slandardized operation ‘and management techniques, IF you prefer to be ‘an indeperdent aperatce or prefer to do business using your awn methods, franchising isnot for you, A franchisee loses his or her identity to the benefit of the franchisor. ‘The franchisor does not share n any tosses but docs share in the profit, ‘The franchisee usuatly has to purchase all goods and supplies from the franchisor only. The contract between the partis is usually 10 the benefit of the franchisor a2 US. Sai! Business AdministrationDisclosure Document ‘The Federal Trade Commission requires that franchise sallers provide censain information in a derailed disclosure \locument to help & prospective buyor evaluate the Lranchise oppertuniny. This informacion includes. ‘Names and addresses of other purchasers, +A fully audited Financial statement of the franchise seer, * ‘The background and expericace of the key executives of the franchisors staff. The vost required wo start ard maintain the business. # The responsibilities you and the franchisor will share, A goad frenchisor usually encourages prospective. franchiseas to visit and tlle to other owners of the franchise. This ceraily shauld be done! Other Considerations An attorney should assist the prospective franchisee 10 ‘evaluate the franchise package. An accountant may be ‘ooted 10 determine tha full cats of purckasing and ‘operating une business, as well as the potential profit 1 the franchisee. Belore purchasing a franchise, carefully consider the level of independence you will maintain, how comprehensive the operating controls are, and the Full ‘cosis of purchasing the franchise. Also, be sure 1 ask about the vermis and conditions for reselling your franchise, Although the success rare of franchises is high, very independent people with their own concepts of operating ‘a business may not be the type to open a franchise. (ote) COST ACCOUNTING Cost accounting, in a broad sense, means accurmalating all the costs associated with an activity (manufacturing, reuiling, providing a service, ec.) and organizing them in a meaningful way to (1) satisty financial reporting requirements and (2) achieve understanding of the costs of the activity for control and oplimization purposes. “There isa distinction between general accounting and cost accounting, Although costs are of primary concem ia broth, general eceounting is concerned more with the total couts ofa business. These costs are usually classified into ‘well-established summary level accounts, such as cast of goods sold, selling expenses, administrative expenses. advertising and research, Cost accounting details costs of individual products by the types of costs (caw material, dict labor, es») and by tne depastmnents (cost centers) wilhineacl of the business fonctions (manotacturing, selling, administration, el.) Cost accounting is used 16 + Control business operasins by detsiling the important costs ofthe business, permiting analysis of these costs and indicating where corrective action is required if easts are not meeting expectations (budgets standards, tc), Optimize basiness performance by using cost

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