Tax is a dirty word

Well it's official - the state of Pennsylvania LOVES to tax its residents. One type of resident, however, seems to pay more than others. That resident is one who participates in 'sins,' like drinking (Allegheny County has a special drink tax to fund public transportation) smoking (currently about $2.45 per pack in PA) and gambling. MAdditional legislation is being proposed in Pittsburgh to tax gambling profits more so that the city can balance the books.

One sin flies under the radar, however, and it's actually worth examining - pornography.

It certainly makes one stop and ask why, doesn't it? After all, we're more than happy to tax smokers until they are literally blue in the face, and taxing adult beverages hasn't hurt profits or the number of drinks ordered. Doesn't it stand to reason that our society's appetite for pornography would remain consistent even with additional taxes?

Come to think of it, doesn't it make sense that the adult entertainers might actually be required to pay a portion of their hourly rate and claim 'tip' income, similar to my favorite waitress at Susie Q's?

While I'm no proponent of paying taxes, this industry has gotten a free pass too long and instead of burdening industries that are already paying more than their fair share, like bars and restaurants, shouldn't another industry shoulder some responsibility? Particularly when that industry likely serves alcohol and allows smoking?

So why don't our legislators touch this proposal with a ten foot pole (pun intended?) Only Senator Jane Orie, a Republican from McCandless, has attempted to tackle the debate so far, and she is getting no traction whatsoever.

As a free market thinker, it seems to me that our legislators are sending a clear signal that rather than stimulate the economy with tax paying businesses like restaurants, casinos, service companies, etc., they are suggesting it makes better business sense to get into the pornography industry. After all, it's basically a tax free business that has proven to be recession-proof. What kind of message is this? The industry is likely responsible for as many marital conflicts as drinking problems, gambling problems, etc., so if that's the hurdle to be classified a 'sin,' pornography definitely fits the bill.

It's got to be more than that. Perhaps our legislators have friends that run in these circles and contribute to not only their personal campaigns, but their personal entertainment as well. Who knows.

In any case, this is actually one tax I'd support completely, as it would actually legitimize the business, its participants and those who enter the darkened-doors.

Oh behave!

Good news coming out of Washington! Apparently there is no inflation and things aren't costing more.

What? Does anyone in Washington purchase their own food, gasoline or healthcare? I forgot - those expenses are covered by lobbyists.

On a serious note, the CPI is down about 1.3% compared to a year ago, meaning that goods or services that cost you $10 a year ago now cost about $9.87. So what's the real story?

Behavior finance and economics suggests that most consumers feel pain more vividly than they feel joy. Basically, we like to avoid losing money more than we like making the same amount of money, even though 'old school' economics teaches us that consumers seek to maximize their pleasure, or 'utility.'

Former Wimbledon champion and tennis great Ivan Lendl perhaps said it best when he was quoted saying "I hate losing more than I like winning." Remember, this is coming from a guy who used to win all the time.

We drive around searching for gas that is $2.72 per gallon instead of $2.75, but won't cross the street for cheaper gas that's $2.08 instead of $2.11. Why? It's a better bargain in the second scenario, after all.

The applications for the economy are far-reaching. We see gas prices going up, but forget that they are down 30% from a year ago. That doesn't offset the 29% increase in prices of fuel over the past six months. We have short term memory, and the figures seem to support behavioral theory. Consider the following (yes, I'm keeping the math simple because it's early and my brain isn't working too well yet)

Assume that gas a year ago cost $3.00 per gallon. A 30% drop in fuel would mean that gas costs $2.10. WOW! That's signficiant. Oops. Now gas goes up 29%, resulting in a new cost of $2.71. Yikes! That hurts, even though it's still less than the original starting point of $3.00.

The same calculations can be applied to the stock market. Assume your retirement plan had $50,000 a year ago and the market lost 25%. You'd be down to $37,500. It takes a 35% gain this year to get back to square one. Sadly, this is what's been going on with investments the past two years, creating opposition to something called the wealth-effect. In short, if consumers feel wealthy (good returns on their 401k, appreciating values on their homes, lower unemployment figures, etc.) they are more likely to spend. There hasn't been much good news or even 'paper returns' to allow consumers to feel wealthy - even a nice return in the market the past six months.

To further support this 'behavioral stuff,' as my wife calls it, consider an even-money bet. Let's say I flip a coin and we bet $1. If it comes up heads, I win $1 from you. If it comes up tails, you win $1 from me. Easy enough? We know that most people would take the bet. What if I won two straight times? Three times in a row? How about four or five?

What if I make the bet $10 per flip, or even $50? At what point do you jump off and act out of 'fear' rather than rationality? We allow the dollar amount to skew our ability to judge. Don't worry, I'm guilty of this too. Studies have shown that when the bet goes to $100 per flip, most folks would demand payment of $160 if they win. I'm not about to take the other side of that bet anytime soon, by the way.

See what I mean? We're easily tricked by math and to be frank, it stinks. I fall for it all the time and I study this junk!

So sit back, relax and take consolation in the fact that you are paying less for things today than you were a year ago while you're driving around looking for the cheapest gas station around.

Banking on our uncertainty

In an story that caught about a ten second blurb this week on Friday morning, the Federal Reserve is working on a plan to not only monitor pay compensation but also one that will allow the Fed to adjust or change the pay practices at Wall Street financial firms. Not just firms that accepted bailout funds, but any financial firm that the Fed deems necessary based upon the firm's excessive risk-taking practices. Also note that the language does not simply limit the pay for executives at the firm. It has the right to limit the pay to anyone that works at the firm according to a Wall Street Journal report.

Excuse me, comrade?

Where does one begin in an attempt to shoot holes in this idea?

Perhaps the easiest target is the Federal Reserve itself. You know the group, right? The same group that sets interest rates in order to manipulate the economy, avoiding recessions, inflation, speculative practices, steering the U.S. to continued economic prosperity and ensure that banks continue to lend to businesses and indivuals that deserve a loan. How's that working so far, Mr. Bernake?

Maybe it's better to look at the Fed based upon the past. The same history that gave former Treasury Secretary Hank Paulson a blank check to bailout Wall Street firms (of which I was critical, I might add.) The same history that kept interest rates artificially low for too long in order to allow the gluttonous behavior to continue. The same history that took budget surpluses at the end of the 1990's to a whopping $11 trillion debt. Again I ask, how's that working?

Consider the impact of keeping overnight rates at 0% (not a typo) since December of last year and no sign that they are going up anytime soon, and then asking a banker to not take some risk with 'free' money. Oh yeah, while you're at, throw in the fact that the Fed is asking banks to make loans to get the economy rolling.

Oh, maybe I'm being too harsh.

Surely there's some good, right?

Ah yes, the same Federal Reserve that has partnered with ACORN since 1977 to enforce bank compliance with the Community Reinvestment Act. In mortgage land, CRA loans (as they are called) are also known as 'subprime' mortgage loans to folks that generally would not qualify for a home based upon credit or ability to repay. How's that working?

To be fair, I hate the banks. Ask any of my students, and they will tell you the adjectives I use to describe most bankers are "lazy, fat and boring. And lazy. Did I mention lazy?"

But to be true to my roots, I also believe in capitalism, entrepreneurial spirit and the corporate structure. If a publicly traded bank like, oh I dunno, Bank of America, wants to make loans it thinks will perform and reward shareholders, shouldn't they be allowed to do that? After all, it's their job to maximize shareholder wealth - not anyone else's wealth. SHAREHOLDER wealth. If the shareholders think the CEO and board are doing a lousy job by taking too much risk with too little potential return, they can (and often will) fire the CEO and replace the board.

Similarly, if the U.S. government wants to get into the banking business, they have two ready-made platforms to execute that plan while remaining outside the circle of overseeing pay for private firms. Maybe the names Fannie Mae and Freddie Mac ring a bell in your head. If the Fed wants to be in banking, turn Fannie and her brother Freddie into large national banks that are required to adhere to strict compensation, risk and corporate management guidelines. Make them play by the same liquidity rules as the other banks and let all of the banks duke it out. Guess who will win, comrades? Yep. You, me and cousin Vinny due to increased competition and a level playing field.

What's next? Will the Fed determine it's their job to monitor and adjust the pay for professional athletes? Does Big Ben really deserve $110 million to throw a football? After all, he's taking a LOT of risk going out there against 330 pound men eager to rip him to shreds. Maybe they will think that doctors should only earn "X" per year regardless of their specialty, or that accountants cannot earn more than "Y." The system is already in place around the country in the form of government pay scales and in many instances labor-contracts, which primarily exist between governments and their employees, the exceptions being large unions like the auto-workers, mine workers, steel workers, etc.

Farfetched? We already have a minimum wage. Doesn't it stand to reason there could be a maximum wage? And while we are accustom to having a minimum wage to assist those with few valuable skills and protect workers from abuse, how does it feel knowing the shoe could be on the other foot, limiting your skills and placing a maximum value on what you have to offer? It's not as crazy as it sounds, folks. And it's happening and a rapid pace.

I'm not in the predicting business, but here's one for ya.

There are going to be three very large national banks in the next three to five years that are entirely government run. Their names are Bank of American, Chase and Citigroup. They will be merged and monitored by Fannie Mae and Freddie Mac, who will report directly to the Federal Reserve Board. The Federal Reserve Board is going to become a fourth branch of government.

Hold onto your wallet and get out your voter card to make sure it's still either Republican, Democrat, Independent and not Socialist or Communist.

Health care reform

Let me be the first to admit that I seldom, if ever, need my employer-sponsored healthcare package. I'm probably one of the lucky ones. I'm also not a doctor (and I've never played one on TV) so I don't know the total story when it comes to billing, paying, services, wait times in emergency rooms, elective surgeries, etc.

With that said, however, I understand business, finance and people...in that order.

So it's no surprise that business people despise the new healthcare reform package offered up by the government. And to be fair, who can blame them? The current tax system already imposes 15-35% income tax on businesses, and individual states throw more on top. Mix in 7.5% taxes into the social security fund, 1.65% into unemployment on the first $7,000 earned by each employee and most businesses can fairly say they pay upwards of 45% to the government. That's a lot of money, particularly on small business owners, which make up 80% of all employers in the US according to the Small Business Administration. If you owned a business that made $100,000 per year before taxes, how would you feel if you only took home $55,000 -$60,000 per year and were being asked to pay more?

Not sure about you, but I'd hire fewer people and actually consider firing a few, too. That doesn't sit too well ever, but especially now given our current 9.5% (reported) unemployment.

On the finance side, the system stinks worse than the Pittsburgh Pirate's front office (maybe) and there's no end in sight. How can an insurance company charge one fee, accept another from the healthcare provider and not be held to better standards? While I fully support price discrimination, as most economists would (if you don't know what price discrimination is, think "Ladies night" or "kids eat free" or the way the airlines price tickets and you'll understand the concept) health insurance price discrimination makes no sense whatsoever from a financial point of view. The pricing scheme is so convoluted that I actually do know why things cost so differently from one provider to the next - they don't know how to price their product or service.

People. Now this is a different story entirely.

Shame on us. We know better, yet we continue to try and get something for nothing or ask for more support so that we don't need to modify our behavior that lead to the problem! Rather than asking Uncle Sam to come up with a solution, maybe it makes more sense to modify our diets, exercise more, smoke less and eat more veggies so that we don't need to go to the doctor's office as often. If we go less, the demand for the product goes down and providers would need to find a better method to attract our business, such as, oh I don't know.... LOWER COSTS?

Ah, the "preventive" maintenance argument. That one hurts the most, as it actually involves personal responsibility, but it makes the most sense.

Think about it. If fewer of us needed to go to the doctor's office, emergency room, surgeons, etc. because our bodies were better equipped and healthier, those needing services would have quicker access, less tired healthcare providers and insurance companies that weren't questioning everything?

I'd love to call it innovative, but it's as old as the hills.

So consider my healthcare reform today by reforming your old habits. Take a walk, turn off the television and put down that bag of chips.

Finding the Perfect Balance

Okay, I confess.

This is a misleading title intended to draw in you readers that are opposed to doing hard numbers and would rather focus on the soft sciences of psychology, marketing, etc.

Gotcha!

The perfect balance I am referring to is the Balance Sheet. This simple, usually one-page document gives a snapshot of any given business at one point in time - typically at the end of the month of a business quarter/cycle.

The beauty with the balance sheet, though, is that while tiny in size, it is a magnifying glass to everything goin on within the business itself.

Remember, the left side has to equal the right side! As a result, the assets (left side) are equal to liabilities (debt) + capital (owner's equity.) Whew. That was hard.

Take a look at the one below:

Weeklybusinesstips

June 8, 2008

Assets Liabilities

Cash $50,000 Short-term Debt $30,000

Accounts Rec $40,000 Accounts Payable $50,000

Merchandies/ Salaries $110,000

Inventory $100,000 Total Current Liabilities $190,000

Total Current

Assets $190,000 Long-term Debt $20,000

Plant/Equip $30,000

Accumulated

Depreciation (2000) Owner Equity $8000

Total Assets $218,000 Total Liability/Equity $218,000

Yes, I know it's exciting to read a balance sheet on a blog; especially one as basic as this. But the ramifications from the balance sheet are enormous, and our understanding of the business grows tremendously once we begin to dig into the balance sheet and discover that things exist there.

First, and foremost, is notice that the assets are listed from most liquid to least liquid.

Why is this the case?

As business owners, I don't need to tell you that cash is king. It's the most easily understood, and universally accepted, forms of payment. You don't need to process anything more than a receipt and the corresponding deposit slip, as the bank accepts these funds the instant they hit your account.

Account receivable, on the other hand, are from your credit paying customers. Aside from the credit card comany taking their 2-3.5% fee on each transaction from you, there is always the risk of the purchase being disputed by the customer, and the processing time takes a few more days. Thus, AR is not as liquid as cash.

Finally, inventory is listed as a current asset and considered the least liquid. This is the result of fluctuations in the business cycle and an ever-changing consumer demand for your product. Additionally, your accounting method will need to be considered for the balance sheet, as the price you paid two weeks ago to make your product may be higher or lower than when you purchased the materials. FIFO and LIFO are important elements to consider for this entry.

On the liability side, the same science is applied, using short term debts and accounts payable as the most necessary payments, followed by longer-term liabilities.

So you don't need to be a rocket scientist to realize that if you reduce your liabilities, a.k.a. - costs, expenditures, debts, etc. and your assets stay the same, your owners equity has to increase in order to balance the account! That's why costs are so important with what we do.

Imagine how great this balance sheet would improve if we simply cut our accounts payable by 20% to a total of $40,000. The owners equity would increase from $8000 to $18,000! And that doesn't even factor the possibility of increasing cash balances with increased sales or higher prices.

A few final thoughts on the balance sheet.

1. It is not wise to skip over a balance sheet. While elementary in scope, that is intentional. The balance sheet is intended to be the glossary for accompanying financial statements such as the income statement, statement of cash flows, profit and loss statement, etc.

2. The balance sheet is a snapshot of one day in time! Keep it consistent and monitor your balance sheet frequently. If not daily, at least weekly, and make it the same time each week. For instance if you have large sales on the weekend, get a Monday morning balance sheet.

3. Pay attention to variables within your business that fall into categories that can jeopardize your equity position on the balance sheet, such as accounts receivable and accounts payable. While it might increase sales in the short-run, relaxing credit standards to sell more items is seldom a wise move for the long-haul. Similarly, review your vendor accounts frequently and push for better terms as your performance paying the accounts improve. For example, you may have a perfect record paying within 30 days to all of your vendors. Go back and ask for a reduced bill if you pay in full within 15 or 20 days, such as a 2/15 net 30 (this means a 2% reduced bill if you pay it within 15 days, or just full payment if you pay after 15 but before 30 days.) Most vendors will work with you so long as your credit history with them is positive.

4. Don't dwell over the numbers! It's too easy to become bogged down and get frustrated when things don't turn your way on the balance sheet. We will later discuss how to improve cash flows, so just be cognizant of your balance sheets and find ways to make minor modifications to your business process that result in increased cash balances, reduced inventories and lower costs.

Please send your questions and/or comments to me anytime! I'd love to know that you're reading and enjoying.

Finance 101

The first question I ask students each semester is "who wants to be here?"

No hand ever goes up. The next, obvious, question is "who has to be here?"

All hands go up.

Such is the life of a Finance teacher and number junkie. My goal is to teach every person I come into contact with in an appropriate setting about numbers. There is no need to be afraid of numbers.

In fact, as business people, it is our job to EMBRACE numbers. This is the language of our business, folks! Regardless of what marketing people tell you, or your lawyers tell you, or your advertising department tells you, the bottom line for your business is, well, the bottom line!

Please understand something, though. Finance is NOT Accounting! Accounting is a tiny segment within Finance, kind of like being a quarterback is part of a football team or cheese is a part of pizza.

So why do we run from numbers?

The answer is simple - numbers paint an accurate picture. All the time. Everytime.

Reality is a hard thing to comprehend when we have plans for big things. Reality gets in the way of our dreams and desire to grow, grow, grow!

It's the same reason we don't write down our Mission Statement, Vision Statement, Business Plan or even a daily plan!

When we see it in writing, it becomes real to us. It reminds us that there are things left to do on our list - things we haven't accomplished yet, rather than things we have accomplished so far.

As business people, we don't like to be reminded of our failures, and finance does just that on a daily basis through our balance sheet.

Each week, I am going to discuss a different element of finance and why it is so important to simly learn the language of finance, whether you are the President of a billion dollar company or a sole proprietor doing part-time work to supplement your "real" job. Once you learn the language of business (finance) you will make smarter business decisions based upon increasing cashflow rather than simply focusing upon what is in the bank account each day. The difference between the two is like night and day, yet few business owners really "get it."

My job is to make you "get it," and I will utilize many means to get you there.

I urge you to write me with questions, comments or opinions, as I am a lifelong student of the game of business and finance. No topic is too small or too big, and I am also simply asking you to pass this site on to two people that you think could benefit from this site. I can also answer personal finance questions, although I am not a licensed financial advisor. (I am, however, in the process of trying to pass my series 6, 63 and 7 - but it's merely for my own skill set and not for profit right now.)

The blog will be updated weekly, most likely every Monday morning to get you started.

Thanks!