As we enter a new tax season, manufacturers should consider options that may benefit their business. While this topic has been discussed in past Manufacturing Insights articles, the cash basis method of accounting remains an important concept for many manufacturing companies to consider.

TCJA: A Recap
The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting.

Pros & Cons of Cash Basis Accounting
Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred. The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

Who is Eligible?
The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for the cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of the inventory for tax purposes. Combining these opportunities could yield considerable benefits.

The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. Likely, many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK Manufacturing Industry Group at 330-758-8613 or manufacturing@hbkcpa.com.

*This is the first in a series of articles addressing the impact of the TCJA on the Manufacturing industry.

TCJA: A Recap

The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. Many of these new or altered provisions directly affect manufacturers, and in this and subsequent articles of a series of articles, Monitoring Manufacturing: Effects of the New Tax Code, I’ll address those likely to have the most impact on our industry.

Pros & Cons of Cash Basis Accounting

One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting. Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred.

The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

Who is eligible?

The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of inventory for tax purposes. Combining these opportunities could yield considerable benefits.

The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. It is likely that many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK CPAs & Consultants’ Manufacturing team at (330) 758-8613.

Michael Kapics, CPA, CCIFP, and Construction Industry Group Leader for HBK CPAs & Consultants, would like to share the following article written by Brandon Dougherty, CPA, which highlights several important recommendations to assist contractors in maneuvering through turbulent economic times.

In times of economic prosperity, contractors tend to be less concerned about surviving and more prone to taking unnecessary risks. But it is in times of relative security that business owners are in the best position to prepare their companies for the inevitable less prosperous times.

Set Realistic Expectations for Growth
In bull markets, many business owners take advantage of improved margins and increased cash on hand to grow their businesses. While their overall growth strategy might be sound, the implementation of an effective strategy is imperative to ensure that the expansion does not negatively impact the company’s liquidity. Rapid expansion into new, unfamiliar geographic areas or service lines can be disastrous if not carefully planned. Entering new markets can lead to losses in the new initiatives and put additional stress on established operations.

Further, significant increases in the size of individual projects, whether in a new geographic area or a new service line, can appear attractive on the surface because revenues are likely to increase. But higher revenues do not necessarily translate to higher profits. Especially if a company is unfamiliar with the licensing requirements and regulatory environment in a new state or municipality, what sounded like a great idea around the boardroom table, could ultimately destroy what the owners have built through years of dedication and hard work in their field.

When planning for expansion it is essential that the business take a deliberate, measured approach to ensure that the new enterprise does not negatively affect the existing operations. Realistic growth plans typically extend 12 to 36 months and allow the businesses to evaluate and react as things unfold during that time.

Invest in Your Human Capital
Another leading cause of contractor failures relates to performance and personnel issues. A lack of skilled labor has impacted many of the nation’s contractors. While this can make a successful expansion nearly impossible, it is also a struggle for many businesses just trying to maintain their existing levels of operation. Inadequate training or experience, as well as an insufficient quantity of personnel, can halt a growth plan in its tracks. A strong business invests in its workforce through formal, on-the-job training at all levels, and develops a culture of loyalty, ownership, urgency and accountability.

Prudence in Prosperity
Maximizing distributions to owners, deferring the reduction of debt, and other policies that erode a strong financial foundation can squander a company’s opportunity to truly improve its financial footing. Contractors should avoid big-ticket items like planes, boats and equipment unnecessary to the business, as the cost and upkeep of such items can be burdensome when cash flows are tight and margins are compressed by an economic downturn. Resale values are also typically substantially depressed during down markets. Instead of splurging on non-vital items, business owners should invest a portion of their profits in short-term, liquid investments as a way to ensure future cash flow.

Create a Long-Term Succession Plan
Succession planning plays a huge part in the long-term viability of a company. Retirements, unexpected deaths, or other changes in leadership can result in a shift in focus that can lead to abandoning ways of doing business that led to the company’s success. With no plan to ensure continuity in the event that a death or disability could cause a change in the culture, key staff members could become disgruntled, and some of them might ultimately leave a business at a time when they are needed most.

The topic of succession can be an unpleasant conversation, but it is critical for owners of small and medium-size businesses to have a plan in place for what happens when they move on, by choice or otherwise. Having a trusted advisor knowledgeable about succession planning can ensure a thorough and objective analysis of all factors.

Economic downturns, national or local, external or internal, are inevitable. Informed, thoughtful planning is the best way to ensure your business will survive the next one. For questions, please contact Brandon Dougherty of HBK’s Construction Industry group at BDougherty@hbkcpa.com