In many respects, management of cash flow for a tax preparation firm is easier than for many types of small business.  There is no inventory of goods to tie up cash.  Payment for services occurs at the time the finished tax return is delivered to the client.  Moreover, a tax preparer has at least a working knowledge of accounting – with many holding the title of CPA.

Like any other small business, though, tax preparation firms are bound by the tenets of good accounting – chief among these being that businesses live or die based on how well management oversees the flow of cash in and out of the company.

Of course, a firm can operate unprofitably.  In fact, there are income-sheltering strategies that use losses in one business to reduce the overall tax burden to a parent corporation that operates multiple companies.  The IRS even allows a company to operate at a loss for up to three years (out of the previous five) before they start to wonder whether in fact the “business” is just a hobby or tax dodge.

Cash flow management is not simply a statement included with the firm’s annual financial reports.  It is a process that must be monitored and managed throughout the year.  Cash flow information needs to be analyzed at least once a year, but it may need to be more frequent if the firm encounters a warning flag, such as an inability to meet payroll or pay outstanding bills.

Cash flow management can’t be done in your head. Much like effective marketing, it needs to be analyzed, bolstered with facts and data, and put to paper for future reference. Nor is cash flow the same as your bank balance – you can maintain a high bank balance by not paying vendors or not paying payroll taxes, but neither of these is good cash flow management.

Visually, the process looks like this:

A few notes on this process:

• Preparing the “Statement of Cash Flows” before the plan organizes the data from the previous year, and provides your accountant with the opportunity to give input and raise any red flags.
• Businesses are not static; they change almost daily. This makes monitoring of cash flow and adjustments a critical, ongoing step in the process.
• The process is not just about managing expenditures. Equally important are the investments made to increase and hold the cash until needed. A qualified advisor can help make recommendations on these investments.
• The best tool for monitoring and organizing cash flow is a good accounting software program. Most major accounting programs offer the means to do so, as do a host of special software solutions and apps.  In 2014, the Direct Capital blog summarized a list of the top 50 applications.

According to Dunn & Bradstreet, "90 percent of small business failures are caused by poor cash flow. Put simply, not enough cash coming in the door and too much going out. Getting paid on time and managing cash outflows is critical to business success." 

How does a small tax preparation firm avoid falling into a cash flow crisis and survive for the long term?  Here are ten essential strategies:

• Create a three-scenario plan. An effective cash flow management plan is more than a single view of the coming year.  The plan should include three different scenarios – one each for the “least likely,” “most likely,” and “better than anticipated.” As a rule of thumb, create the “most likely” scenario first. Then, assume the unexpected and lower projections by a reasonable percentage (e.g., 10 percent) to match a reduction of cash coming into the business. Finally, assume a banner year and increase the cash coming in by a reasonable percentage. For reference, the Franchise Help website estimates that revenue for tax preparation firms grew by five percent each year from 2010 to 2015, with slightly higher growth ahead until at least 2018.

• Arrange for a “bridging loan.” Even the best of companies can hit a point at which cash inflows can’t keep pace with outflows (examples might be a disaster not fully covered by insurance, or a national economic recession).  Unfortunately, most businesses fail to prepare for this obvious situation, and are forced to try to arrange financing at the same time virtually every other business is doing the same and credit is scarce.  Plan for this with your bank with what is called a “bridging loan,” a short-term loan designed to cover the shortage until sales can pick up again.

• Move to the Cloud. Moving to cloud-based software can reduce the total cost of the software, as well as the expense of updates.  In addition, most cloud storage vendors offer low-cost, secure storage and archiving services, eliminating the need for other solutions for backup and storage.  The majority also offer a client portal service, providing a secure means of communication and file sharing with clients.

• Reduce operating costs. There are a number of strategies for this, but two worth mentioning are a more effective use of technology and planning for staff levels during tax season.  In the technology arena, a number of new products and enhancements have streamlined operations, enabling more work in less time. These include signature pads; data input and organization systems, such as GruntWorx; and tax workflow software systems that organize and speed the preparation of tax returns.

• Consolidate equipment and assets. Another strategy for reducing operating costs is to consolidate equipment and assets.  Flex-time employees, for example, might share desk space and computers.  Rather than placing a printer on each desktop, the firm can utilize a central printing station with a high-capacity, fast laser printer.  This eliminates the cost of maintenance on multiple computers, as well as replacement costs, expense for toner cartridges and other related necessities.

• Understand the “breakeven point” for the business. The breakeven point is the estimated point in the year at which cash inflows and outflows are equal, and overall cash flow is neither negative nor positive.  It is used to analyze the impact of investments or purchases, or the level of revenue needed to keep the cash flow positive, among other things.

• Submit payroll taxes and reports in full and on time. Every business understands the necessity of filing quarterly and annual income taxes, particularly tax professionals who prepare the filings for other businesses.  Business owners who do not effectively plan and monitor their cash flow can find themselves in the awkward position of having sufficient cash to meet payroll and keep the firm operating – but not enough to pay the taxes.  For those with no bridge financing or other credit resources to rely on, “going long” on payroll taxes is a truly bad idea.  The penalties are steep, and the action itself puts your firm on the wrong side of the IRS.

• Keep expenses realistic. Another way to run into cash flow problems is to assume that the “better than anticipated” scenario will be the “most likely.”  Since it is unlikely that revenue will increase substantially in a single year, the way to accomplish this is to be optimistic about expenses.  This “nothing can go wrong” scenario could cause the firm to slip into a negative cash flow situation when it is not forecast to do so.

• Institute spending controls. As a rule, employees of the firm are not a part of the cash flow management processes.  It is therefore possible for employees to spend more than is forecast for all the right reasons, but nonetheless may cause damage to the firm.  Areas to watch are petty cash accounts, corporate credit cards, travel and meal expenses, or investment in technology (e.g., cellular products such as phones and smart watches) with the expectation that the company pay for it.

• Don’t assume the status quo. Just because some elements of cash flow have been stable in the past does not guarantee they will remain so in the future.   Your tax service can suffer from increased competition, interest rates may rise, a recession may cause credit sources to become more conservative, or inflation may unexpectedly drive up expenses.  This is the reason for planning with three scenarios.

• Growth may not be the best strategy for cash flow management. The faster a firm grows, the more cash will be needed for facilities, staff, and services. These are up-front costs that can’t wait the four or five months before the revenue can catch up.  Growth is the best strategy when it has been planned for and cash reserves are sufficient to fully fund the growth with no increase in planned revenue.  A conservative approach to growth will best meet the needs of the firm.

Whether the tax service is a solo practice, has only a handful of employees or is a larger firm with multiple locations, cash flow is a critical part of managing the firm from one day to the next.  The process can be labor-intensive, but there are tools available to automate parts of the task.  What’s more, much of the heavy lifting can be conducted in the off season, when demands on the time and attention of owners and managers are substantially less.

A lack of cash flow is the single largest factor in the failure of small businesses.  But with a little preparation, planning and monitoring it need not be for your tax practice.