SalonOvations Tax and Financial Primer (S Business Series)

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Tax and Financial Primer Mark Battersby

7

(a division of Delmar Publishers) 3 Columbia Circle, Box 12519 Albany, New York 12212-2519

NOTICE TO THE READER Publisher does not warrant or guarantee any of the products described herein or perform any independent not assume, and analysis in connection with any of the product information contained herein. Publisher does expressly disclaims, any obligation to obtain and include information other than that provided to it by the manufacturer. The reader is expressly warned to consider and adopt all safety precautions that might be indicated by the activities herein and to avoid all potential hazards.By following the instructions contained herein, the reader willingly assumes all risks in connections with such instructions. The publisher makes no representationor warranties of any kind, including butnot limited to, the warranties of fitness for particular purpose or merchantability, norare any such representations implied with respect to the material set forth herein, and the publisher takes no responsibility with respect to such material. The publisher shall not be liable for any special, consequential, or exemplary damages resulting,in whole or part, from the readers’ useof, or reliance upon, this material.

Cover Design: Brian Yacur

Milady Staff Publisher: Catherine Frangie Acquisitions Editor: Marlene McHugh Pratt Project Editor: Annette Downs Danaher Production Manager: Brian Yacur COPYRIGHT 0 1996 Milady Publishing Company (a division of Delmar Publishers) M

Inlernalional TilorasonPublishing company

Printed in the United States of America Printed and distributed simultaneously in Canada

For more information, contact: SalonOvations Milady Publishing Company 3 Columbia Circle,Box 125 19 Albany,New York 12212-2519 All rights reserved.No part of this work coveredby the copyright hereonmay be reprodud or used in any form or by any means-graphic, electronic, or mechanical, including photocopying, recording, taping, or information storage and retrieval systems-without the written permissionof the publisher.

1 2 3 4 5 6 7 8 9 1 O X X X O 1 0 0 9 9 9 8 9 7 9 6

Library of Congress Cataloging-in-Publication Data Battersby, MarkE. SalonOvations’ taxand financial primer/ Mark Battersby P. cm. ISBN: 1-56253-215-4 1. Beauty shops-Accounting. 2. Beauty shops-Taxation-Accounting. 3. Beauty shops-Finance. I. Title. HF5686.B34B37 1996 6 57.834 2 0

94-39613 CIP

Contents

Preface

ix

Dedication Introduction

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xi

Networking xii Associations xii The Competition xiii The Money Salon

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CHAPTER ONE

The Business Plan

I

Goals 3 Financial Data 4 Day-to-Day Money Management

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CHAPTER TWO

Basic Bookkeeping and Records

I3

Records 14 Accounting Methods 15 Bookkeeping Systems 17 Inventories 21 Keeping Track 22 Credit Customers 25 Records’ Storage 26 CHAPTER THREE

Decisions,Decisions,Decisions Business Ownerships Lease/Buy 32

27

28

V

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Contents

Owningthe BuildingThat Houses the Business Finding a Professional 000

37

CHAPTER FOUR

Banking Relationships

47

The Loan Package 48 Puttingthe LoanPackage Together Sources o f Funds 52 Borrowing Smart 53 What Money Costs 57 Reasons for Borrowing 59 Finding a Bank 61

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CHAPTER FIVE

Insurance Basics

67

Health Insurance 68 Traditional Insurance 73 Other Insurance 75 Owners and Employees 76 Workers’ Compensation 76 Going Without 82 CHAPTER SIX

Paying for Compliance

83

Is It Tax Deductible? 84 Special Assessments 86 Helpingthe Handicapped Patronize the Salon Americans with Disabilities Act 87 Capital Improvements 90 What Is Best forthe Salon? 92 CHAPTER SEVEN

Controversies

95

Employee/Employer 96 FICA Employees 98

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Contents

Relief Provisions Definitions 99 Audits 101 Home-Based Salons

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CHAPTER EIGHT

Owner Benefits

109

Spouses and Family Members 1 10 Partners 1 12 Estate Taxes 11 3 Enjoying Salon Ownership 1 14 Entertainment Expenses 1 15 Trade Shows, Conventions,and Meetings Goodwill 123

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CHAPTER NINE

Growing the

Business

129

Growth Strategies 130 Growing in Place 133 Managing for Growth 136 Borrowing for Growth 138 Advertising 140 Growth Financing 141 Tax Credits 145 SBA Growth Help 146 SBA Loan Program 147 Benefiting from Women-Oriented GrowthHelp

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CHAPTER TEN

Planning the Future

155

Disasters 156 NetOperating LossesCanMeanCash 157 Acquisitionsfor Bigger Losses 160 Reducing Taxes Now, Slashing EstateTaxes Later 165 Trusts Income Assignment 167

163

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Contents

APPENDIX A

Tax Deduction Checklist

169

APPENDIX B

Sample Tax Return Forms

181

APPENDIX C

Sample Business Records

193

Income Statement 194 Balance Sheet 195 Consolidated Statement of Changes Ledger Journal 197

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APPENDIX D

Blank Sheets

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Ledger Sheet 200 Debit,Credit,and BalanceSheet Index

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Preface

SalonOvations’ Tax and Financial Primer is written for all of those salon owners and managerswho, in order to survive and profit, must deal with our income tax laws and the unusual financing techniques thatface every businessperson every day. It is not a “basic” primer but is instead designed to serve a slightly more sophisticated audience-those who have or hope to soon have theirown salon operations. It should be emphasized that no salon owner ormanager can hope to know it all. However, with this primer as a guide and occasional prod, salon owners should find it easier to make moves that will help increase thesalon’s profitability and lower its tax bill. A wide variety of strategies are covered. They will help at every stage of the salon’s growth and operation. But strategies change, our tax laws change, and society changes so please accept these strategies for what they are-a starting point, a guide, if you will, to achieve the desired goals. Just as not every salon owner or manager will be concernedabout the benefits andpossible pitfalls of acquiring another salon, not every strategy will apply to or even befeasible for every salon owner. As with every guide ever published, this book illustrates possible courses of action, courses that are takenevery day by other salon and business owners. A specific strategy may not be desired by one salon owner or manager and be clearly impractical for another. But in every case sufficient information that should remain validfor the foreseeable future isgiven to enable everyone to explore those strategiesor “guides.” Few salon owners or managers are skilled in every area of salon management, taxation, and financing.For this reason, it is always recommended that salon owners seek the advice and

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Preface

guidance of someone else. There is, after all, such a thing as being too close to the forest to see thetrees. Thus, in additionto providing the strategies needed to guide salons to financial success, I have attempted to show a few professionals salonowners can seekfor advicegeared to their unique business operation. Unbiased,knowledgeable assistance and advice,combined with this guidebook, should help every salon owner and managersucceed, grow, prosper, and, hopefidly, not be eaten alive by our tax system.

Dedication To Laura and Matthew who made this book necessary and Arthur who made it possible.

Introduction

Starting asalon or any other business mightbegin as a way to profit from an existing hobby or special interest. Whether that business activity succeeds, however, depends largely oncommon sense and what the salon owner views as success. As most salon owners and managers are already aware, the income from any activity is taxable. That income, of course, may be reduced by the expenses of the hobby to eliminate a taxbill. However, it isonly a “business” that can go one step further and usetheamount by which the activity’s expenses exceed its income (losses) to offset taxable income fromother sources. Thus, when starting any business, close attention should be paid to convincing the Internal Revenue Service (IRS) that a tax business exists-even if profits are not a goal. Not too surprisingly, many part-time hairdressers,stylists, and other spare-time business operators are more interested in convincing the IRS that the activity is operated with “an intent to show a profit” than with actual profits. And a key factor in convincing the IRS is maintaining books and records for the activity. Records usually only document businessactivities, bookkeeping systems measure the income and expenses. Common sense dictates establishing a goal and charting a course of action to achieve that goal. The tool most often used is a business plan. That business plan will help guide the salon owner to whatever goal is desired, helpconvince the IRS that a business exists for income tax purposes, and, with littlemodification, also helpattract the financing or capital needed to reach that goal.

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Introduction

NETWORKING

No one can successfully operate or succeed in a vacuum. The salon’s books and records are translated, as you will see, into ratios. Those ratios permit comparison of the salon’s costs, profits, or losses with thoseof other salonsor even other businesses. In thecoming pages, salon owners and managers are advised to seek outthe advice of friends and business associateswell asas the professionals they rely on to help the salon succeed. This interaction with others is networking. Networking is a combination of public relations, promotion, advertising,education,management,andmanyotherskills important to the salon’s success. We’ll delve more deeply into many of these areas later, but for now consider the many types of networking usedby salon owners and managers. Explaining to someone on the street whatsalon owners and managers do or the unique services performed by a salon is networking at its most primitive. Membership in business andsocial groups exposes salon owners or managers to an audience of potential customers. No overt selling is necessary. Salon owners who volunteer their services at charity functionsare networking, exposing the services to the participants in the event aswell as the audience at the event and those who might read about the event inthe newspaper. Networking, pure and simple, means letting people know about your profession,your skills, andthe services you perform. Blowing your own horn is not a sin and, inthis day and age of expensive advertising, is almost vital to the salon’s growth. ASSOCIATIONS

Associations that salon owners and managers join varywidely. The bottom line, again, is usually networking andofall the definitions we’ve ascribed to it. Thus, though membership inlocal a business leaguemay benefit the salon owner in the form of better understanding of the tax and regulation climate of the local community, it also is an informal advertisingmedium. Membership

Introduction

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in a trade or professional organization, either national, regional, or local in scope, may not directly help the salon’s business. However, business may improve if that professional qualification or membership ispromoted. The primary purpose of membership in a trade or professional organization is usually education. Groups of professionals have clout with legislators andthe resources to deal with legislation. Exchanging ideas, be they marketing, promotion, costcutting, or whatever, is another benefitof membership in trade and professional organizations. How better to keep abreast of changing styles and fashions, and the best ways to cater to customers desiring those fashions, than through membership in a group dedicated to educating their members and keeping them abreast of those changes? THE COMPETITION

The story of the Hatfields and the McCoys and the feud that continued year after year ais good example of wasteful relationships. A n y salon owner who feels that strongly about the competition is virtuallydoomed to failure. Membership ina tradeor professional organization is essentially banding together with others in the same fieldfor the mutual benefit of all. On a national, state,or regional basis,competition betweenthe members of these organizations is not given much importance.On a local level, there are fartoo many areas where competitorsdon’t speak. In a perfect world, neighboring salon owners or managers would understand that there plenty is of business for both. Warring or competing salons often drive away more customers than they attract.And where that competition involves price-cutting, the customers may benefit while the salon’s bottom line disappears. Cutthroat competition is rarely good for those involved. Competition is inevitable, but should be conducted with a sense of fair play. If one salon is flourishing while another is struggling to survive, the owner or manager of the struggling salon

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Introduction

might benefit from a few of the promotions undertaken by the successful salon. Similarly, the successful salon might havereached a plateau in its growth and requires some means of handling business it cannot accommodate until expansion plans are completed. A damaging typeof competition would result inthe successful salon being forced to turn away business or make expensive investments in immediateexpansion. The troubled salon might be on a downward spiral financially, but it would be more inclined to transfer its remaining business to the successful salon if they had “shared the wealth” somewhere along the line. THE MONEY SALON

Business techniques and strategies can be taught. Even management skills canbe learned or purchased. But the basics such as competing in afriendly manner, growing by networking, and membership in professional organizations must be acquired. In thecoming pages, a numberof strategies and techniques used by successful salon owners and managers are presented. These are things thatcan be learned. Actually applying similar tax or financing strategies,on the other hand, something is that no salon owner or manager canbe forced to do. Because not all strategiesor techniques apply to every salon and because not allsalon owners or managers will bother to take full advantage of even those moves that will benefit their own salon, everything is presented in a manner that should inform those to whom each area applies. Sufficient information is provided to enable salonowners or managers to know where a particular strategy should be used and who qualifies. The benefits that will accrue are also discussed in an effort to give salon owners or managers some idea of whether implementing a strategy will prove cost effective. In most cases, potential pitfalls, restrictions, and limits are also presentedto help thosewho do decide to benefit from one of these strategies or techniques to do so successfully. But, almost

Introduction

xv

without exception, the salon owner or manager will not find a step-by-step diagram. Explored insome depth are the skills requiredfor successful salon management and suggestions on how to retain the services of many different types of professionals skilled in those areas the salon owner or manager lacks. "hose professionals, friends, business associates, and even competitors are the ones to provide the final analysis of the importance to the salon of each taxor financial strategy. But, as mentioned, salon owners or managers, armed with all of the tools necessary to help thesalon grow, must make the finaldeterminationabouttheadvisability of anycourse of action. They must also make the effort to implement strategies, create the long-term goals for their salons, and manage the salon operation in a mannerdesigned to reach those goals with a minimumof detours.

This Page Intentionally Left Blank

CHAPTER ONE

The Business Plan

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Tax and Financial Primer

During the preparation of a business plan,salon owners will, at least if they do it properly, discover many areas in which they lack necessary skills or knowledge. Since one of the criteria the IRS has adopted for determining the existence of a business is the skill of the principal or his or her advisers, the discovery of a lack of skills or knowledge should result ina searchfor qualified advisers. The business plan takes many shapes and forms, and in reality, any form that provides the answers to the basic questions is fine. But as thebusiness plan is being prepared, keep in mind the purpose for which it will be used. As already mentioned, a business plan should always serve as a guide for salon owners or managers to decide where the salon is going and how to reach the desired goals. With little modification, that business plan can also serve as an educational tool, educating suppliers, potential investors, and bankers aboutthe business and how the salon operates. In other words, it can also be a public relations tool. With slightly more modification, that business plan becomes a financial proposal. An excellent substitute for the application forms demanded by bankers, the business plan in its financial plan mode outlines the state of the business, defines its goals, and provides basic financial data about the owners, managers, and employees; the salon’s market; andhow it views its position in the market. The business pladfinancial proposal substitutes for the loan application used by most banks by providing all of the information usually required by those institutions but, in most cases, slanted to putthe best light on all facts and figures. No, it is not an attempt to defraud or fool the bank but, rather, an effort to present everything in the best format under the most favorable circumstances and, if necessary, provide explanation for any unusual circumstances or justify anything that might be viewed with anything less than favor by a potential lender. Rarely does a loan application provide the space to explain, justify, or shade the salon’s business figures and even more rare is a loan application that provides enough data to educate the

The Business Plan

3

loan officer about the basic business, its principals, and thegoals for that operation. GOALS

The goals stated in thesalon’s business plan are usually specific ones. Instead of merely saying that the salon will be profitable a t the end of its second year, the business plan usually states that the salon will have cornered 10 percent of the salon business inits defined market area, have three full-time employees, and be looking fora location for a second shop. The basic demographic data for a given area is available from a varietyof sources. With that data it is fairly easyfor the salon owners or managers to determinethe projected market for their particular services and extrapolate a realistic share of that total marketthey canhope to corner. Data from the U.S. Census Bureau is also available from a variety of sources. A number of specialists are fully capable of interpreting that data or providing realistic figures that can be used to estimate marketing potential and future income or even in defining which areas would be best for the type of services that will be offered. Reaching Those Goals

The primary purpose of the business plan is not the goals so much as the path thesalon owner or manager plans to follow to reach them. Thus, it is easy to discover that there is anuntapped market for a salon in agiven area and that it can be expectedto break even within a year. But how willthe salon reach that break-even point? After assembling all of the basic information about the principals’ backgrounds and experience and resources available to them, it is time to list the other “tools” available to the salon owner. Is the lastavailable commercial building in that market owned by the new salon owner? Is the salon owner the only one within one hundred miles who is proficient in the lateststyles?

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Tax and Financial Primer

Entering thesetools into the marketingplan not only allowsthe salon owner to review them, it also helps an outsider, potential lender, or even a supplier thinking about extending credit better understand thewhole operation. Some salon owners also share this business plan with their landlord. As a negotiating tool, the business plan reveals to the landlord or any othercreditor where the business is financially, where it hopes to be in the future, and how it proposes to get there. FINANCIAL DATA

Everyone is well aware that any financial data can be interpreted in a variety of ways depending upon who is doing the interpreting. To the uninitiated, for instance, it might be quite impressive to learn thata salon actually had gross income in excess of $100,000 last year. At least it would impress anyone unaware that the salon operation had invested well over $10 million in remodeling and new equipment, waspaying the highest salaries around, and had twice the numberof employees and threetimes the advertising budget of its nearestcompetitor. Juggling the Figures

Admittedly, there arethose who juggle the financial figures that go into a business plan and probably those who go overboard in presenting thequalifications of the owners and principals in the business. But who are they fooling? A businessplan is meant tobe first andforemost a guide for the salon owner or manager. Exaggeratingthe salon manager’s skills might impress a potential lenderor investor, but to those who know and need this information to manage the business who is kidding who? Thus, thebusiness plan is meant to be the owner or manager’s tool, a tool establishing goals for the salon and marking out a course of action and a path to follow that will hopefullyend up at thatdesired destination. Akey to long-term success is a real-

The Business Plan

5

istic, honest business plan. On a short-term basis, the need is for day-to-day money management. DAY-TO-DAY MONEY MANAGEMENT

To reach the long-term goals established by the business plan it is necessary to take it one step at a time. Breaking down the expected annual results intomonthly or even weekly goals gives salon owners or managers a better idea of where the salon stands in relation to those long-term goals. Meeting the short-termgoals and, eventually, the long-term goals requires that the salon keep books and records. So important are those books and records not only from a management standpoint but also from a cost-reducing and tax-saving standpoint, that we’ve devoted an entiresection to that topic. Properly set up, these books and records should not require an inordinate amount of time. Thus, the salon owner or manager has time to refine the long-term goals of the salon and keep abreast of the marketplace. The following is a general outline (notnecessarily in order) of the areasyou should address in your business plan.If an area does not pertain to your business exclude it. But if this outline does not include an area you feel is important, by all means include it in your plan. Remember that your plan is original and unique. 1. Introduction A. Brief overview of planned venture. 1. Who are you? 2. What are you trying to do? 3. Who is going to run the salon? B. Synopsis of business idea, goals, and featuresthat make this venturedifferent from the competition and thatwill help it succeed. C. Education section. 1. Explanation of salon industry as whole. 2. Need or opportunity for more salons.

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Tax and Financial Primer

3. What everyone outside of the industry mustknow in order to evaluatethis business, i.e., howsalons operate andmake their money and the services they perform. D.Goals. 1. What doyou hope to achieve with this business venture? 2. What will be your rewards? 3. What will be the future of this venture?

2. The Business Plan Objectives and Goals A. Description of the business. 1. Type of business. 2. Status of business. 3. Business form. 4. Why is your salon going to be profitable? 5. Have you spoken with other people in this kind of business? What were their responses? 6. What is special about your business? 7. How will you run thebusiness? 8. When will (did) your business open? 9. What hoursof the day and daysof the week will you be in operation? 10. If business is seasonal, will the hours be adjusted seasonally? 3. The Marketing Plan A. Basic marketing considerations. 1. Who is your market? Who buysthe kind of services you will offer? (This may be defined by geographic location or socioeconomic factors-income, age, occupation, ethnic factors) 2. What is the presentsize of the market? 3. What percentage of the marketwill you have? 4. What is the market’s growth potential? 5. As the market grows, does your share increase or decrease? 6. How are you going to satisfy your market?

The Business Plan

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7. How are yougoing to price your services or the products you offer for resale to make a fair profit and, at the sametime, be competitive? B. When you have a feel for your market, the following questions can be raised. 1. How will you attract andkeep this market? a) The imageof the business. b) Pricing. c) Customer service policies. d) Advertising. 2. How can you expand your market? C. Pricing considerations. 1. What price do you anticipate getting for your services? (In setting the price for your business, you must consider cost of resale merchandise and supplies, labor and operating costs, and plannedprofit.) 2. Is the price competitive? 3. Why will someone pay your price? 4. How did you arrive at the price? Is it profitable? 5. What special advantages do you offerthat may justify a higher price? (You don’t necessarily have to engage in directprice competition.) 4. The Location

A. Building, transportation, parking, and renovation considerations. 1. What is your address? 2. What are thephysical features of your building? 3. Is your building leased or owned? State the terms. 4. If renovations are needed, what are they? What is the expected cost? (Get quotes in writingfrom more than one contractor and include them as supporting documents.) 5. What is the neighborhood like? Does the zoning permit your kind of business? 6 . What kind of businesses are in the area? 7. Have you considered other areas?

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Tax and Financial Primer

8. Why is this the rightbuilding and location for your business? 9. How does this location affect your operating costs? 10. Will the customer come to your place of business? 11. How much space do you need? 12. Will you want toexpand later on? 13. Do you require any special features in plumbing, lighting, heating, ventilation? 14. Is parking available? 15. Is public transportation available? 16. Is the location conducive to drop-in customers? 17. Will travel timebe excessive? 18. Will you prorate travel time to house calls? 19. Would a location close to an expressway or main artery cutdown on travel time? 20. If you choosea remote location, will youhave to pay as much as you save in rentfor advertising tomake your service known? 21. If you choose a remote location, will savings in rent offset the inconvenience? 22. If you choose a remote location, will the customer be able to readily locate your business? 23. Will the supply of labor be adequate and thenecessary skillsavailable? 24. What are thezoning regulations of the area? 25. Will there be adequate fire and police protection? 26. Will crime insurance be needed and be available at a reasonable rate? 5. The Competition A. What is the competition in the area you have picked to locate? 1. The number of firms that handle your service. 2. Does the area appearto be saturated? 3. How many of these firms look prosperous? 4. Do they have any apparent advantages over you? 5. How many look as though they’re barely gettingby?

The Business Plan

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6. How many similar salons went out of business in this area last year? Can you find out why they failed? 7. How many new salons opened up in the lastyear? 8. How much do your competitors charge for similar service? 9. Which firm or firms in the area will be your biggest competition? List the reasons for your opinion. 10. Who are your five nearest competitors? 11. How will your operation be better than theirs? 12. How is theirbusiness? Steady? Increasing? Decreasing? Why? 13. How are their operations similar and dissimilar to yours? 14. What are their strengths and/or weaknesses? 15. What have you learned from watching their operations? 6. The Management A. This segment should include responses to the following questions. 1. What isyour business background? 2. What management experience have you had? 3. What education have you had (including both formal and informal learning experiences) that have bearing on your managerial abilities? 4. Personal data: age, where you live and have lived, special abilitiesandinterests,reasons forgoing into business. 5. Are you physically up to the job? Stamina counts. 6. Why are you going to be successful at this venture? B. Related work experience. 1. Direct operational experience in this type of business. 2. Managerial experience in thistype of business. 3. Managerial experience acquired elsewhere, whether in totally different kinds of businesses or as an off-

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Tax and Financial Primer

C.

D. E. F.

shoot of club or team membership, civic activities, church work, or some other. Duties and responsibilities. 1. Who will do what? Write major job descriptions. 2. What will be your form of legal organization? 3 . What areyour accounting needs? What records will you keep? 4. What areyour insurance needs and how much? 5. Who reports to whom? 6. Who makes the final decisions? a) Time for planning and reviewing plans. b) Major operating duties (purchasing, sales, personnel, promotion, production, and so forth as appropriate for your business. c) Planning. Identify your majorstrengths and weaknesses. Salaries (simple statement of what the managementwill be paid). Resources available to thebusiness. 1. Accountant. 2. Lawyer. 3. Insurance broker. 4. Banker. 5. List others,if applicable.

7. Personnel A. What areyour personnel needs now? In the nearfuture? In five years? B. What skills must theyhave? C. Are the people you need available? D. Full- or part-time? E. Salaries, commissions, or hourly wages? F. Fringe benefits? G . Overtime? H. Will you have to trainpeople? If so, at what cost to the business (both time and money)?

The Business Plan

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8. Application and Expected Effect of a Loan A. How is the loan or investment to be spent? B. What is (are) the item(s) to be bought? C. Who is the supplier? D. What is the price? E. What is thespecific model name and/or number of your purchase? F. How much will you payin sales tax, installationcharges, and/or freight charges? G . How will the loan make your business more profitable? 9. Financial Data A. Project a statement of income and expense, B. Determine the financial requirements to get the business started. 1. List all permanent assets required and the value or cost to obtain each. a) Inventory. b) Equipment. c) Leasehold improvements. d) Automotive or trucks. e)Fixtures. f) Buildings. g) Prepaids. h) Miscellaneous. 2. Determine the working capital needs (cash) to get the business self-supporting. (Total cash needs will equal the highestcumulative negative cash balance in ( b ) plus (a)and (c), or startup expenses plus largest cumulative cash operating deficit plus contingency fund equals cash needs.) a) Estimate one-time startup expenses (nonasset). b) Estimate monthly revenues and disbursements (cash flow) until the time that the business is self-supporting. c) Estimate contingency fund safety factors.

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Tax and Financial Primer

C. List the money and/or value of assets you intend to invest in thebusiness (owner’s equity). D. Project your financing needs. (Value of permanent assets plus working capital equals total funds needed minus your investment equals total financing required.) 10. Attachments A. Proforma financial data. 1. Proforma cash-flow analysis. 2. Income statement. 3. Proforma balance sheet. 4. Ratio analysis. 5. Financial standards. B. Break-even point analysis.

CHAPTER TWO

Bookkeeping and Records

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Tax and Financial Primer

When all is said and done, there are really only two reasons for a salon to keep records of its operations: they are required by law, and they are extremely useful in managing the business. Of course, there is also such a thing as too many records or too much bookkeeping. So do salon owners or managers know what happy medium to aim for? A good way to determine what types of records are required for a particular salon business is to take a closer look at what records are utilized by others with similar operations. And consider what records and information are actually needed t o run thesalon operation for maximum profit. RECORDS

Obviously, records must be kept to help determine the taxliability of the beauty business. Regardless of the specific type of bookkeeping system employed, our tax laws require that the records be permanent, accurate, and complete. Those records must also clearly establish income, deductions, credits, employee information, and anythingelse specified by federal, state, or localregulations. Remember, however, that the law does not require any particular kindsof records, only that they be completeand separate for each business. At theoutset,the type andarrangement of books and records most suitable to a particular salon operation should be established, keeping in mind the various taxes for which the business is liable and the times at which they are due. If this is not an area in which the salon owner or manager feels competent, outside professional help is required. A naturalquestion at this point is: Who is going to maintain those records? Frequently, the answer is an accountant or bookkeeper. But can the salon afford the services of an accountant to maintain the much-needed books and records? Can the operation afford even a part-time bookkeeper? Setting up a system for good record keeping need be done only once; doingit efficiently makes things much easier later on. Thus,in most cases, thereis no real needfor professional

Basic Bookkeeping and

Records

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accounting help beyond the setting up of books. If loans or local operating rules require financial statements or regular audits, accounting assistance may be necessary on a regular basis, but never purchase more outside professional aid than is required or than will be used. (Refer to Appendix C for sample business records.) Accountant versus Bookkeeper

An accountant is generally defined as one who interprets the day-to-day or monthly financial figures of a business and translates theminto financial statements. Those financial statements are thenused by banks and financial institutions to evaluate the business andby the owner, hopefully, to better manage thesalon operation. A bookkeeper, on the other hand, is one who merely enters the daily, weekly, or monthly figures of the salon business. Since most bookkeepers also pay bills and preparethe payroll, they are usually closer to the daily operation of the salon. Unfortunately, when a supplier, landlord, or bank asks for financial statements they generally require accountant-prepared statements. In some cases only statements prepared or approved by a certified public accountant are acceptable. Thus, thedifferences (and prices paid) between accountants and bookkeepers vary widely. There are public accountants, certified public accountants,and even tax accountants. Who is employed and on what basis is something we’ll delve into later in a section on finding qualified help for the salon. ACCOUNTING METHODS

When it comes to creating a record-keeping system, it should be every salon owner/operator’s goalto keep it as simple as possible. After all, the owner’s time is valuable. If records are too complex, the owner or manager will spend too much time maintaining them; too simple, of course, and those records will not give the owner the information needed to successfully manage the salon.

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Tax and Financial Primer

Later, we’lllook a t a fewof the many ways those often incomprehensible financial statements and thefigures from the salon operation’s ownbooks can be used to chart the salon’s financial course, but of more immediate interest is the method to be used for accounting purposes. Two basic systems of accounting are used-theso-called cash method and the accrual method. Which one is actually best for a given business depends on a variety of factors that should be reviewed by an accountant. Variables such as sales volume, the legal form of the business, and whethercredit will be extended all affect this decision. Cash Basis

The cash basis method of accounting is generally the easiest to use. All income becomes income when received and all expenses become expenses when theyare paid. In otherwords, both income and expenses are put on the books and charged to the period in which they are paid or received. If the salon is using the cash basis, it can defer or postpone income to the following year so long as it isn’t actually or constructively received in the current year. A check received by the salon, but not cashed until the following year is still income in the present year. Therefore, to legitimately shift income to the following year the salon operation will either have to delay billing until thefollowing year, or bill so late in thepresent year that a present-year paymentis unlikely. Since the key to a consistently low tax bill is the shifting of income to atax year when expenses are higher, or shifting expenses to a high-income tax year when they would be more valuable in reducing the salon’s tax bracket, the ability to legally shift income and deductions becomes important. Accrual Basis

With accrual-basis accounting, both income and expenses are charged to the period to which they should apply, regardless of

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17

whether money has actually been received or paid. Thus, the salon that decides to pay an annual bonus to its employees may legitimately claim a deduction for that bonus in the present year, and actuallypay the money out earlyin thenext year. It goes without sayingthat thecash basis, real-time method of accounting is farsimpler than theaccrual method of accounting where expenses become expenses when incurredand income becomes income when billed. However, the accrual method is mandatory for purchases and sales whenever inventories are used in thesalon business. Bigger beauty care operations, those with receipts of more than $5 million per year, mustuse the accrual method of accounting if they are operating as eithera corporation, partnership, or trust. Fortunately, theTax Reform Act of 1986 that created the mandatory accrual-basis accounting also included a number of exceptions that permit some businesses to use the cash method of accounting no matter how large their gross receipts. Those are farming businesses, partnerships without corporate partners, sole proprietorships, and so-called qualified personal service corporations. The latter include those performing services in the fields of health, law, accounting, actuarial science, performing, or consulting. (For the record, 95 percent of the stock of a “qualified” personal service corporation must beownedby shareholders who are actually performing services for the corporation.) BOOKKEEPING SYSTEMS

Double-entry bookkeeping is usually the preferred method for keeping business records, making use of journals and ledgers. Transactions are normally entered first in a journal, and then monthly totals of the transactions are transferred or posted to the appropriate ledger accounts. (Refer to Appendix D for blank bookkeeping sheets.) Ordinarily, the ledger accounts include five categories: income, expenses, assets, liabilities, and net worth. Income and

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Primer

expense accounts are totaled or closed each year. Asset, liability, and net worth accounts are maintained on a permanent and continuing basis. Many smaller salons have discovered that the two steps required in double-entry bookkeeping are both time consuming and complicated. One result hasbeen an increase in simplified bookkeeping systems and theso-called one-write checkbook systems that permit a business to write a check while at thesame time posting the amount of that check to the proper expense account. Single-entry bookkeeping, although not as complete as the double-entry method, may be used effectively in many small businesses, including a salon, especially during theearly yearsof operation. Quite simply, the flow of income and expenses is recorded through a daily summary of cash receipts, a monthly summary of receipts, and a monthly disbursements journal (all too frequently this is merely a checkbook).

Single Entry Using Debit/Credit Method

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19

This system is usually adequate for the tax purposes of many small salons, but successful salon management requires the use of financial figures such as those produced by doubleentry bookkeeping systems. Using the Numbers

To illustrate justhow useful the figures produced by double-entry bookkeeping systems are, consider the basic method for determining the financial position of the salon at any point in time. ASSETS (Things of value)

=

LIABILITIES (Claims of creditors)

+

OWNER’S EQUITY (Claims of owners)

Naturally, thisbasic equation can be modifiedsignificantly to reflect the salon’s form of ownership. For a corporation, for example, the equation would be: ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY

A partnership would be: ASSETS = LIABILITIES + PARTNERS’ EQUITY

The simplified, single-entry bookkeeping system, for its part, can also generate figures to measure the overall performance of the salon: INCOME - EXPENSES = NET PROFIT (OR LOSS)

Both of these basic computations will provide the salon owner or manager with an idea of the financial picture of the salon operation. In reality, however, knowing whether the salon operation generated a profit or loss is immaterial. What the owner or manager should knowis how much profit the salon produced based on the amount of time and capital invested. This detailed information can be obtained by utilizing ordinary ratios.

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Tax and Financial Primer

The current ratio, for instance, compares current assets to current liabilities. It measures the salon’s ability to payits current debtsas they mature. The current ratio of Jones Salon, Inc. is computed as: CURRENT RATIO =

CURRENT ASSETS CURRENT LlABLlTlES

This and other ratios permit the salon owner/operator to compare apples with oranges. A salon with $40,000 in current assets can be compared with anothersalon or with any business having assets ranging from $1 to $1billion. Closer to home, this ratio provides a more meaningful yardstick to be used in measuring the profitability of the salon operation. A so-called acid-test ratio (or quick ratio) measures the ability of the salon to meet its current debt on short notice. This ratio does not include inventoryor prepaid expenses; only cash, marketable securities, and accounts receivable-all highly liquid assets-are included. ACID-TEST RATIO =

QUICK ASSESTS CURRENT LIABILITIES

Because the typical minimum acid-test ratio is ordinarily one toone, our hypothetical salon appears tobe in a good shortterm credit position. Of course, this ratio should be compared with industry averages as well as previous operating periods in order to provide an accurate comparison. Just how strong (or weak) a salon is can be measured by the debt-to-net-worth ratio. This ratio is designed to measure the extent to which the operation is financed with borrowed funds. It indicates the amount of funds contributed by creditors as compared with the total fundsprovided. DEBT-TO-NET-WORTHRATIO =

TOTAL LIABILITIES STOCKHOLDERS’ EQUITY

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and Records

21

Finally, the ratio of net income to sales measuresa salon’s profitability by comparing net income and sales: RATION NET-INCOME-TO-SALES=

NET INCOME SALES

This profitability ratio is a critical indicator for any profitseeking salon.Although in our case a profit of 3.7@was realized for every dollar of sales, it was farbelow the national average of 4 or 5 percent for retail establishments. It should be compared to pastperformance to understand the realsignificance. INVENTORIES

Inventories don’t play a large role in most salon operations. Products held forsale tocustomers and inventories of supplies are usually small items on the financial statements. However, large or small, they play a key role in the accounting process. First, of course, the owner or manager must determine the method that will be used to inventory supplies and those products for resale, and then a method for placing a value on them must be determined. LIFO versus FIFO

LIFO (last-in, first-out)is a common methodof inventory accounb ing that assumes the cost of goods soldis calculated on prices paid for the most recently purchased materials and goods. By using recent prices, the cost of goods sold is used to reflect the higher prices that must be paid to purchase new inventory items. Obviously, the LIFO method reducesprofits (because it increases the cost of goods sold). However, it obviously produces a more accurate statementof profits than does the FIFO (firstin, first-out)method of inventory valuation. Under FIFO, which was the most common form of inventory valuation, the assumption is made that the first inventory items

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T a x and Financial Primer

purchased are the first used. However, as prices increase, the FIFO method produces higher profits. Many accountants feel that these profits are unrealistic because they ignore the need to replenish inventories at higher costs. KEEPING TRACK

It goes without saying that all receipts from the salon operation should be deposited in a separate bankaccount with, perhaps, a petty cash fund established for small everyday cash expenses. Naturally, all businessexpenses paid in cash should be supported by documents or receipts that clearly show the expenses were incurred for business purposes. Similarly, all disbursements should be made by check if at all possible so that business expenses can be well documented. If a cash paymentis necessary, a receiptfor the payment, or at least an explanation of it, should be included in the business records. All canceled checks, paid bills, duplicate deposit slips, and other documents that substantiate the entries made in busithe ness records should be filed in an orderly manner and stored in a safe place. In fact, accounts should be classified in groups relating to income, expenses, assets, liabilities, and net worth. Furthermore, asset accounts should be classified as current or fixed, and the date of the acquisition, cost, depreciation, and any other items affecting the account should be recorded. Obviously, every salon should carefully preserve all underlying business papers. For instance, purchase invoices, receiving reports, copies of sales slips, invoices or statements sent to customers, canceled checks, receipts for cash paid out, and cash register tapes mustbe meticulously retained. Theynot only are essential to maintaining good records but may also be important if legal or tax questions ever arise involving one of these items. Payroll recordspresent another set of problems. An employer, regardless of the number of employees, is required to maintain all

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23

records pertaining topayroll taxes (income tax withholding, Social Security, and federal unemployment tax) for at least four years after thetax becomes due or is paid, whichever is later. "he payroll for a small salon is usually a relatively simple task if the owner or manager usesa good pegboard or one-write system. Any office supply store can provide samples of the different write-it-once or pegboard systems available. "here are generally four basic records that every salon will generate andbe accountable for with anyrecord-keeping system. 1. Sales records 2. Cash receipts 3. Cash disbursements 4. Accounts receivable

Records supporting entries on federal tax returns should be kept until the statuteof limitations (ordinarily three years after the tax return is due) expires. Copies of federal income tax returns should be kept forever; they may even be helpful to the executor of the owner's estate. In addition to these four basic records and the tax documents, the salon should also maintain records for three other importantitems: capital equipment, insurance, and payroll. Capital Equipment or Fixtures

Equipment records should be kept for all major purchases so that depreciation deductions can be determined for tax purposes. Records are maintained for all purchased equipment, whether purchased outright, on a contract basis, or completewith a mortgage. Major equipment purchased by the salon is considered an asset even though it may have been financed. As it is paid off, the salon buildsup equity in that equipment that can be entered onto the salon operation's balance sheet as an asset. Information that should be kept relating toequipment purchases includes the date purchased, the vendor's name, a brief

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description of the item,how it was paid for (even the check number if appropriate), and the full amount of the purchase. Insurance

All records pertaining to the salon’s insurance policies should be kept. This includes auto, life, health, fire, and any special coverage obtained to decrease the risk of liability in aspecific area such as plate glass insurance. Thesmart salon owner ormanager lists the carriers that the policies are with as well as the indemnity agents who issued the coverages. It is also a good idea to maintain a record of any claims made against those insurance policies in order to resolve any future misunderstandings that might arise. Payroll

There are more than twenty different types of employment records that must be maintained just to satisfy federal recordkeeping requirements. For example, the records that relateonly to income tax withholding would include:

.

Thename,address, and Social Security number of each employee The amounts and dateof each payment of compensation Amount of wages subject to withholding in each payment The amountof withholding tax collected from each payment Any reason that the taxable amount is less than total payments Any statements relating to employees’ nonresident status The market value and date of noncash compensation All pertinent information about payments made under sickpay plans The employees’ withholding exemption certificates Agreements regarding the voluntary withholding of extra cash Dates and payments to employees for nonbusiness services Statements of tips received by employees Requests for different computation of withholding taxes

. . =

. . .. .

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25

.. .

The amount of each payment subject to FICA tax The amount and date of FICA tax collected from each payment An explanation of the difference, if any

. .. m

The total amountof salaries and wages paid during thecalendar year Amount subject to unemployment tax Amount of contributions paid into the state unemployment fund Any other information requested on the unemployment tax return

CREDIT CUSTOMERS

There isalso the matter of record-keeping for credit customers. Most salon owners and managers create a permanent record that is maintained separatelyfrom sales slips and invoices. This record usually shows the date, invoice number, amount of any new charges, a running balance of the total amount owed, the date and amountof each payment actually received, a record of any invoices, collection letters, and collection phone calls made to the customer. Good receivables can easily become overdue. Collection problems and even losses can result if the receivables are not monitored frequently and carefully. This review will allow ownersand managers to pinpoint the potential problems as early as possible. Early identification, in turn, will decrease the potential of the account becoming a loss. Credit experts claim that the difficulty in collecting an account increases in direct proportion to the age of that asset.

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Tax and Financial Primer

RECORDS’ STORAGE

The accumulation and utilization of these books and records would be greatly impaired if they were lost, stolen, or damaged as a result of storing them on the business premises. Protecting the bookkeeping records used daily on the salon’s premises from theft,fire, or otherdamageensurestheir safety. Complete removal of all records not needed in the daily operation of the business makes sense and may help the business to be rebuilt if it ever suffers severe damageor destruction.

Decisions, Decisions, Decisions

27

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Tax and Financial Primer

President Harry Truman had a sign on his desk in the White House that stated, “The Buck Stops Here.” Today’s salon owner or manager is rarelyfaced with as many tough decisions as President Truman, but the decisions the owner or manager must make will determine the size of the salon operation’s tax bill and, in fact, whether it survives and prospers, or loses money and dies. Obviously, some decisions are what today’s teenagers refer to as “no-brainers.” Taxes and death immediately leap to mind, but even in these areas theproper decisions from the inception of the business on are important.After all, thesize of the salon’s tax bill and thesurvival of it after the deathof the principal are all directly related to decisions made by the salon owner every day. To list even the major decisions made by both fledgling and existing salon owners/operators would be mind boggling. Fortunately, armed with the pros and cons and some background information, almost anyone can make a good decision, not necessarily the right one every time, but a good decision that won’t add to the burden of the salon operation. BUSINESS OWNERSHIPS

When it comes to the form under which the salon is operated, the choice appears quiteclear cut. If the salon owner has themoney, a corporation is formed. This has the effect of protecting the owner/operator from liability for the salon’s business debtsmost of the time. If more than one individual is involved, perhaps a partnership would be better. Or what is wrong with a sole proprietorship? Sole Proprietorship

A sole proprietorship is the original form of business ownership. It is also the simplest because thereis no legal distinction between the sole proprietor as an individual and as a business owner. A sole proprietorship is an organization owned by and

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usually operatedby a single individual. Its assets, earnings, and debts arethose of the owner. Sole proprietorships offer advantages not foundin other forms of business ownership such as retention of all profits, ease of formation and dissolution, and ownership flexibility. All profits and losses of a sole proprietorship belong to the owner. If the salon is very profitable, this can be an important advantage. Retention of all profits (and responsibility for all losses) provide sole proprietors with the incentive to operate the business as efficiently as possible. Disadvantages associated with a sole proprietorship include the unlimited financial liability, limitations on financing, management deficiencies, and a lack of continuity. Because there is no legal distinction between the salon operation and its owner, the sole proprietor is financially liable for all debts of the salon business. The financial resources of a sole proprietorship are limited to the owner’s personal funds andmoney that can be borrowed. Sole proprietors usually do not have easy access to large amounts of capital because they are typically small businesspeople with limited personal wealth. Banks and other financial institutions are often reluctant to risk giving loans to such small organizations. Partnerships

Partnerships areanother form of private business ownership. As defined by the Uniform Partnership Act, they are associations of two or more persons who operate abusiness as co-owners by voluntary legal agreement. General partnerships arethose in which all partners carry on the business as co-owners and all are liable for the business operation’s debts. Partnerships offer the advantage of ease of formation, complementary management skills, andexpanded financial capability. It is relatively easy to establish a partnership. As with sole proprietorships, the legal requirements usually involve registering thebusiness name and taking out the required licenses. It is usually wise to establish written articlesof partnership specifylng the details of the partners’ agreement.This helps clar-

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Tax and Financial Primer

i@ the relationship within the business/form and protects the original agreement upon which the partnership wasfirst based. Partnerships offer expanded financial capability through money invested by each of the partners. They also usually have greater access to borrowed funds than do sole proprietorships. Because the individual partners are subject to unlimited financial liability, banks are often likely to advance loans to partnerships where theywould be denied to a sole proprietorship. Like other forms of business ownership, partnerships have some disadvantages, including unlimited financial liability, potential partner conflicts, lack of continuity, and complexity of dissolution. Each partner is responsible for the debts of the salon and each is legally liable for the activities of the others, both financial and legal. As with sole proprietors, partners are required to pay the total debtsof a partnership. All partnerships, from beauty and hairdressingsalons to rock groups, face the problem of personal and business disagreements among the participants. If those conflicts cannot be resolved,it is sometimes best todissolve the partnership. Continuity of the partnership is disrupted when a partner is no longerable or willing to continue in thebeauty business. Unfortunately, it is not always easy to dissolve a partnership. Instead of simply withdrawing the investment in the business, the partner who wants to leave must find someone(an existing partner or outsider) to buy his or her interest inthe salon. Corporations

A corporation, by definition, is “anassociation of persons created by statute as a legal entity (artificial person) with authority to act and to have liability separate and apartfrom its ownership” (Rate A. Howell, John R. Allison, and Nate T. Henley, Business Law, 2d ed., Dryden Press, 1981, 1014). Because corporations are legal organizations apart from their owners, the liability of each owner is limited to the amount that person invests. Because corporations are, as mentioned, considered separate legal entities, the stockholders (owners) usually have limited

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financial risk.If the salon fails, theycan lose only the amount of their investment. This limited risk is usually cited as the most significant advantage of corporate ownership over other forms of ownership. Expanded financial capabilities is usually another advantage of corporate ownership. This may allow the corporation to grow and become more efficient than it would if the business were set up as a sole proprietorship or partnership. Some disadvantages are also inherent in corporate ownership. Corporations are the most difficult and costly ownership form to establish; they often face a multitude of legal restrictions and their impersonality can alienate some customers and employees. As separate legal entities, corporations are subject to federal and stateincome taxes. Corporate earnings are normally paid to the shareholders in the form of dividends. Thus, a corporation pays income taxes a t the corporate rate and passes along any Form of

antage Advantage Ownership Sole financial Unlimited profits all Retain Proprietorship formation Ease liability of dissolution and Financial limitations Ownership flexibility Management deficiencies Lack of continuity Partnership

Ease of formation Complementary management skills Expanded financial capabilities

Unlimited financial liability Interpersonal conflicts Lack of continuity Complex to dissolve

Corporation form

Limited financial liability Specialized management skills Expanded financial capacity Economies o f largescale operation

Difficult and costly to

employees

Tax disadvantages Legal restrictions Alienation o f some

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Tax and Financial Primer

earnings left after the bite of corporate taxes to the individual shareholders who are then taxed at their personal tax rate on those dividends-in other words, a double taxation of corporate earnings. “S” Corporations

Federal taxlaws and many statelaws permit a business operating as a corporation to choose to be treated in thesame manner as a partnership, thus passing income, deductions, and other tax benefits along to the individual shareholders where theyare taxed at theshareholder’s tax rate. These so-called “S”corporations, in essence, enjoy all the benefits of a regular, or “C,”corporation without the corporate tax bill. The unique tax status of an “S” corporation illustrates a major consideration in deciding what form of business is right for the salon: taxes. At the present time, the top tax ratesfor corporations arelower than those for individuals. Thus, the amount of income (or losses) of the salon and the bottom-line tax impact are major considerations when deciding whether to operate as a sole proprietorship, partnership or “S” corporation with income taxed a t individual tax rates, or as a regular corporation facing a separate, perhapslower, tax. An incorporated salon faces a tax unique to regular corporations, a penaltytax for accumulating too much in earnings. This accumulated earnings tax is assessed only when a regular corporation accumulates already taxed earnings or profits beyond the reasonable needs of the business. In other words, our lawmakers don’t want any salon to “hide” income in the business and created this taxto act as a deterrent. LEASE/BUY

The one financial question to which there isno one right answer for every salon owner or manager isthat of whether it is better to lease or to buy the assets or equipment needed by and used in

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the beauty operation. Further complicating this issue is the fastgrowing equipment rental industrythat offers almost everything needed by the average salon for a period of time ranging from a few hours to a year. Determining the costs of the various options available to the salon operation is rarely easy. On one hand, the salon owner or manager maylocate needed equipment or the financing required to purchase that equipment outright at anextremely low price. A leasing company, for its part, may be able to pass along the lower prices its increased purchasing power warrants in the form of attractive lease rates. There isalso the common sense factor to be considered. If a piece of equipment is needed only for a short period of time or will quickly become obsolete, common sensedictates that it should be leased or rented. After all, what salon owner or manager wants to own out-of-date, obsolescent, or unneeded equipment? Those newly created beautybusinesses and otherssuffering from a chronic lack of cash are denied the luxury of making the lease/buy/rent decision. If the salon operation doesn’t have the funds available to purchase equipment outright, leasing may be the only option. Obviously, at the root of every lease/buy/rent decision is the financial condition of the salon. A salon owner who simply does not have the funds to invest in needed equipment or property may not be able to buy or to obtain the financing needed to purchase outright. Conversely, many salon owners or managers would not like to see additional debt on the balance sheets they present to their bankers,debtors, and investors. Leasing is usually an off-balance-sheet transaction meaning that it isnot reflected on the operation’s financial statement. There is also the matter of determining whether the salon can afford to own, maintain, and operate the equipment. Buying or leasing equipmentis merely the first and most expensive step. With ownership, even with leased equipment, comes the responsibility of maintaining it and operating it. Plus, many localities also levy a tax on operations’ property and equipment.

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Tax and Financial Primer

After the financial position of the salon has been considered and the anticipated use, life, and cost-saving value of the new property has been weighed, the finaldetermination for any lease/buy/rent situation isthe comparative costs for each course of action. costs

At its most basic, the cost of leasing or purchasing is the actual out-of-pocket expense to the salon operation. If a new piece of equipment is needed, advance payments and the monthly lease payments are compared to the down payment and monthly interest and principal payments required for the purchased equipment. Unfortunately, things are not always that simple. That basic lease payment is, of course, fullytax deductible. In other words, the actual out-of-pocket cash expenditure can be reduced by any taxsavings in order to produce a netcost for leasing. The amounts expended for purchased property and equipment, on the other hand,are not fully tax deductible; only allowed depreciation write-offs and the interest paid may be claimed as an income tax deduction. The salon operator computes a lease payment reducedby the tax savings it generates. This figure is then compared to the amount actually expended to acquire the needed equipment reduced not by tax deductible payments but, rather, by the depreciation and interest deductions permitted. And, to be reallyaccurate,this computationshouldextend over the entire lease period or until the end of the purchased equipment’s useful life.And don’t forget to consider the valueof the equipment to the salon operation at theend of both the lease period and the depreciable life as well as anycosts that might be incurred to dispose of that equipment when it is no longer needed. Depreciation

Purchasedequipmentisusually fully depreciable. A $1,000 piece of equipment has a book value for depreciation purposes of

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35

$1,000 regardless of how much was actually paid out or how much debt was incurredto acquire it. Thus, using our standard depreciation method, a depreciation deduction equal to 20 percent of that equipment’s cost is available in thefirst year. Using a five-year life, assuming it was acquired at midyear and employing the standard declining-balance method of depreciation, the deduction for year one is 20 percent; year two, 32 percent; year three, 19.70 percent; year four, 11.52 percent; year five, 11.20 percent; and year six, 5.76 percent. That’s right, using $200 as a down payment on a $1,000 piece of equipment and financing the balance generates an immediate depreciation deduction of $200. Assuming that the salon operation is in the34 percent corporate tax bracket, that $200 depreciation deduction reduces the taxbill by $68. The averagesalon operation, however, is permitted to immediately write off or expense up to $17,500 in newly acquired equipment each tax year. That so-called Section 179 first-year deduction means that the entire$1,000 equipment cost qualifies as a tax deduction. Reducing the salon’s taxable income by the equipment’s full $1,000 cost produces tax savings of $340. Cost of Money

Now that the salon owner or manager has some means of comparing the actualout-of-pocket, after-tax cost of buying with the after-tax cost of leasing, unfortunately, even that comparison does not provide a completely accurate evaluation. After all, to this point we’ve ignored the cost of money. Bankers have long treated money as the commodity that it really is. In other words, money either costs something to use, or it loses something when it is gone. Translated to our leas&uy/rent equation, that money used as a down payment on purchased equipment would, hopefully, earn income or make the salon operation more profitable by reducing debt elsewhere. Using it as a down payment on equipment creates a lostopportunity to earnincome or reduce other costs. That lost opportunity cost figure must be added to the total cost of purchasing property or equipment.

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Tax and Financial Primer

On the other side of the coin, leasing by its very nature is designed to free up cash and improve any operation’s financial statements. Thatavailable cash, at least in awell-managed salon, reduces costs or generates income that reduces the cost of leasing. Obsolete Equipment

The final evaluationin thelease/buy/rent equation is what to do with obsolete or no-longer-needed equipment and at what cost? Leased equipment can frequently be purchased outright by the user at the end of the lease termwithout affecting the tax status of the transaction. Purchased equipment may have a useful life longer than its tax life, thereby exceeding its depreciation period. If the equipment’s tax life has not finished but its usefulness to the salon operation has, it must be abandoned and an abandonment write-off taken on the tax return. Thatabandonment loss includes both the remaining book value of the asset as well as anycosts of disposal. Leased equipment, if nolonger useful to the salon, maysimply be returned to the leasing company at theend of the leasing period. Leasing companies have a built-in profit. Reserves are also included for added-on contingencies.Rental equipment is usually only utilized on a temporary, short-term basis, so there are no problems or costs associated with disposing of it. Which brings us back to an initial evaluation4an thesalon operation afford to purchase the needed equipment or property or must it lease? If, and only if, bothavenues are anoption is the financial comparison necessary. Obviously, the widely varying financial conditions of most salons and the degree to which they have access to financing make it impossible to provide a stock answer to the lease/buy/rent question. Purpose of Equipment

Before these complex financial equations are made and compared, more and more salon owners and managers are thinking about the purpose for which the equipment is going to be used, its expected usefulness to the salon business, and itsavailability. That iswhere equipment rental enters theequation.

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Many salons have only a temporary, seasonal, or occasional need forsome types of equipment. Or perhaps they are anticipating the future needs of the growing business and, in the meantime, renting different types of equipment will enable them to evaluate its usefulness to the operation. Rental payments, just as lease payments, are usually fully tax deductible, with no worries about what to do with the equipment. That question so basic to the success of every salon, whether to lease, buy, or rent, is first and foremost one of common sense. Is the equipment or property really needed? Can the operation afford it? How long will it be used and remain useful to the salon? What will it cost the salon out-of-pocket? And, finally, will the acquisition of that equipment, whether leased or purchased, increase the salon operation’s income or result in sufficient savingsto pay for itself? OWNING THE BUILDING THAT HOUSES THE BUSINESS

Although many salon operators own their own homes, several cars, and perhaps even a boat or recreational vehicle, few own the shop that houses their business. What few salon owners seem to realize is that thebenefits of shop ownership frequently equal home ownership and thensome. Whenever any salon owner is about to acquire real estate from which a business will operate, another question immediately arises:who ought to own the property? Should the beauty or salon corporation buy it or should the individual owners take title andlease it to the salon business? Very often, for reasons that involve income and estate tax planning as well as overall flexibility, it is the individual who should assume the title.However, before exploring the relative merits of corporate versus individual ownership of your business premises, let’s take a closer look at a few economic and tax fundamentals of real estateownership. 9

Depreciation: The owner of real estate is permitted to deduct a yearly amount for the wear and tear that the building is

Tax and Financial

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Primw

undergoing.Althoughdepreciation is not an actual cash expense but an accounting concept, it is deductible against income from the property. Today, our tax law makes shop ownership even more lucrative because the property can be depreciated or written off over a fifteen-year period giving quick tax returns. Mortgage interest: This item is fully tax deductible for tax purposes, whereas principal payments are nondeductible. Equity buildup: With every principal payment on the mortgage, the owner’s equity or free-and-clear share of any sale proceeds increases. Appreciation: As salon and shop rents increase, the owner of a building enjoys increases in theunderlying value of his or her business property. Hopefully, the owner will be able to sell the property for more, maybe even substantially more, than waspaid for it. Tax shelter: This term refersto that period of ownership of a property during which the deductible expenses (depreciation, interest, operating costs) exceed the taxable income from the property.

. . .

.

Consider the dilemma facedby Joan andMichael, the owners and managers of Super Salon, Inc., an incorporated hairdressing business. Individually, both Joan and Michael are in the50 percent tax bracket, although their hairdressing salon corporation has been managed to an 18 percent bracket through the use of retirement plans and other deductible items including Michael and Joan’s estimated compensation. Super Salon has been operating for five years out of the same building and now the owner of that building is interested in selling it. The shareholders are equally interested in buying the building and the terms of the deal are quickly arranged. But should the real estatebe acquired by the corporate entity or by the principals individually? Joan andMichael feel that thesalon business should take title to the property. The corporation would get tax write-offs

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for depreciation, mortgage interest, taxes and operating expenses,equitybuildup,andtheopportunityto profit from appreciation in the value of the property. Although these are all desirable benefits, they would, unfortunately, more than likely be misplaced inside the salon corporation. Why? The salon business, as a corporation, is a taxpaying entity separate and distinct from its shareholders. Thus, the tax losses generated by ownership of the real estatewould be used to offset the corporation’s already modest taxable income-modest, that is, when compared to the taxable income of the shareholders. A general rule of thumb in tax planning is to have nondeductible expenses paid by the lower brackettaxpayer and deductible items paid by the higher bracket taxpayer. Thelogical extension of this rule isto put the taxlosses where they will do the most good, that is, with the higher bracket taxpayer-in this case, the principals, Michael and Joan. Thus, thepreferred arrangement would be for Joan and Michael, perhaps in the form of a partnership, to take title to the property and, in turn, lease thebuilding to their salon business. Obviously, as the landlords, Joan and Michael would set a reasonable rental rate for the property. Rentals in excess of the going rate for comparable space might well be disallowed by the ever-vigilant IRS as a disguised dividend, nondeductible by the corporation. Unlike mortgage payments of which only the interest portion is tax deductible, the entire rental deductible is by the hairdressing business. This doesn’t violate our rule of thumb about deductible expenses being paid by the higher bracket taxpayer,at least not really. The rental payments actually represent a tax-deductible means of getting money out of the salon business in a form other than compensation. The rental payments will, of course, be “sheltered” by the partnership’s deductions for depreciation, interest, and so forth. The overall result will be tax-deductible, tax-sheltered income from the corporation, a situation that will continue for as long as the rentis reasonable and the deductible expenses of the property exceed the income.

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Selling the Property

For those salon owners who remain skeptical, our principals, Michael and Joan, should not buy the real estate through the corporation because they will have a difficult (Le., expensive) time getting it out. Suppose for example, that the property is acquired by the salon business and after several years of equity buildup and appreciation it becomes desirable to sell the property to a third party. In all likelihood, the sale will generate a large capital gain to the corporation and bring Michael and Joanback to their taxadvisers to figure out some way to getthe proceeds to them personally. In other words, the adviser is going to have to devise a meansof causing the sale of property by the corporation (taxpayer 1) and thedistribution of the proceeds to the individuals (taxpayers 2 and 3) in such a way as to generate only onetax. The tax adviser can present a few options. One option is liquidation. The real estate and all other assets of the corporation are sold pursuant to aplan of liquidation. The salon pays no tax on the sale, but the shareholders pay capital gains tax when the sale proceeds are distributed to them intheoretical exchange for their stock. Unfortunately, either form of liquidation involves the cessation of the hairdressing business. Another option is redemption. Simply put, the salon corporation exchanges the real estate for Michael and Joan’s stock. This is a perilous alternative because the corporation will definitely pay capital gainstax on the distribution, and Michael and Joan run the risk of having the proceeds treated asdividends. A third option involves a subchapter “S” corporation. The so-called tax option corporation or subchapter “S”entity pays no tax at thecorporate level. Instead all income, deductions, credits, and thelike are passed through to the shareholders. At first blush, the subchapter “S” corporation option should appeal to Joan and Michael because it could pass through the losses from the real estate and pass through the capital gain upon sale of the property. Unfortunately, as attractive as it might seem, the subchapter “S” corporation route falls far short of the individuaVpartnership approach for at least threereasons.

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1. The corporation’s tax bracket is much lower than the shareholders’ (Michael and Joan) respective tax brackets. Thus, Michael and Joancan leave money in thecorporation rather than taking it out as compensation. Earnings not paid as compensation will be taxed at the corporation’s rate and, within certain limits, maybe accumulated. Any compensation received by the shareholders will, naturally, be taxable. 2. Because of the nature of the business, the salon corporation usually carries alower value for shareholder buy-out purposes. Salon owners usually assure themselves or their families of getting the most economic value for their participation by use of fringe benefits. The lower bracket corporation is an ideal vehicle for funding such benefits. They are, however, unavailable to shareholders of a subchapter “S” corporation because it has no independent existence as a taxpayer. 3. Although subchapter “S” corporations may now have qualified retirement plans that areequal to the plans of regular corporations, loans from subchapter “S” corporations are still prohibited. This may be a serious drawback to subchapter “S” status.

As with any tax shelter, real estate “crosses over,”meaning that atsome point the taxable income from the property exceeds the deductible expenses. At this juncture, the crossover point, the owners of the property have several options. They can keep it and shelter theincome by other means, theycan refinance, they can sell, or they can give the property to theirchildren or even to a trust for the benefit of those children or family members. These considerations apply, by and large, to the independent salon owner or the salon corporation with few enough shareholders to make these strategies workable. In these situations, the real estate isusually better held outside of the salon corporation. Although income and estate taxplanning makethis a desirable strategy, whether it would actually benefit a salon owner in your unique situation is adecision usually best left to a professional. So too are the questions of just how and by whom the

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business real estate isto be held and under what termsit is to be leased to thesalon business. FINDING A PROFESSIONAL

When salon owners or managers have medical problems they normally seek medical advice. Why then do so many of those same salon owners and managers tend to shy away from seeking advice or assistance in areas that are vitally important to the health of their businesses? Experienced salon owners are just as apt as neophytes to overrate the extent of their own knowledge or their ability to handle chores that could more economically be left in the hands of a competent professional. Doing it yourself, in other words, can oftenbe far more expensive and troublesome than delegating a chore, project, or crisis to an expert. The advice or services of an expert or professional in a given field doesn’t cost; in fact, those professionals usually more than pay for themselves. Naturally, there is always the problem of finding the right expert or professional, one with the needed skills or knowledge and one who is also affordable. In order to find a qualified, competent, and affordable expert or professional, the salon owner’s first step should be to understand just what services are actually needed and which services would benefit the salon operation the most. After deciding which services are themost important or the most useful in guiding the salon operation’s growth, it is helpful to know to what extent theywill be needed. Will the local business climate or the personality of the salon owner make having a lawyer on call a prudent move? Is the salon big enough-and complex enough-to warrant a fulltime bookkeeper? Or is assistance in setting up the bookkeeping system and help with the annual income tax returns sufficient? Among the manytypes of professionals used by the average salons are accountants and lawyers. Other professionals who may prove helpful include insurance brokers and bankers. As in every field, there are those professionals whose skills can assist

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the salon owner with marketing, advertising,expansion, or loan applications. Of course, there are also general business consultants, financial consultants, human resource consultants, and the like. But, for the time being, let’s concentrate on the most popular and useful types of professionals and see what they can do for a salon. We’ll also address the question ofhow to find those needed professionals. Accountants

A good accountant is ordinarily the single most important outside adviser available tothe majority of salons. Theservices of a lawyer, insurance broker, or business consultant are all vital during specific periods in thegrowth of any salon operation or in times of trouble. However, it is the accountant who willhave the greatest impact on the ultimatesuccess or failure of the salon. As already mentioned, all salon owners and operators must decide whether their salon’s volume of business warrants a fulltime bookkeeper, an outside accounting service, or merelya yearend accounting and income tax preparation service. Remember, however, that even the smallest, unincorporated salon usually employs an outside public accountant to prepare the operation’s financial statements. Whenever money is borrowed, bankers and other lenders normally want to see a balance sheet, an operating statement, or the other financial statements we’ve already discussed. If these have been prepared by a reputable public accountant, they will be far more creditable than if self-prepared. Public accountants must usually meet certain proficiency levels to be licensed by the state in which they practice. This does not ensure that either a so-called certified public accountant or a business accountant will do a good job for the salon operation, but it does narrow the field somewhat. Since most salon owners will be far more successful spending their time doing what they do best, not their own accounting, thenatural question is: How do you find a “good” accountant? Local, regional, and stateprofessional associations are usually quitewilling to provide referrals.

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Primer

The best way tolocate an accountant, however, remains the tried-and-true method of asking others.Ask other salon owners, other small business owners, the salon’s banker or lawyer for recommendations. But even with the strongest recommendation, don’t ever be reluctant to “shop” forthe one accountant or other professional who is right andaffordable for your salon operation. How much does a good accountant charge? Their fees, like those of lawyers, doctors, and other professionals, vary widely. A neighborhood-based accountant may charge $60 and up per hour whereas some of the large, nationally known accounting firms might charge $100 to $250 per hour or more for the services of their personnel. Again, however, the salon operation will usually get what it pays for when it signs on an accountant or accounting firm. Accountants prepare the books and financial statements and, if they are good and doing their job properly, can also provide an early warningof trouble ahead for the salon. Plus, because they areexposed to a variety of local businesses, it is far easier for independent accountants to know where to place the blame for business downturns. Is it the local economy or the salon owner or manager? A salon or beauty-related business can survive and even prosper without an accountant, but thingsare a lot easier if the salon can afford the services of a good accountant. And although small consolation, accountants, even really good ones, are rarely as expensive as another professional often needed by the salon: an attorney.

Lawyers Finding an attorney, specifically the right attorney, early in the salon operation’s growth is extremely important. After all, a lawyer’s input is usually necessary in theformation of the salon business as well as helpful in the intricacies of securing all of the required licenses, permits, and zoning variances necessary before the salon’s doors can open. Lawyers who can meet the needs of a salon should possess several key qualities. Among the most important qualities salon

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owners look for in an attorney are honesty, experience, and availability. Good, honest lawyers will tell salon owners or operators that their legal needs or requirements are outside the scope of the lawyer’s expertise and normally suggest another attorney who might do a betterjob. Somelawyers, even without expertise, will accept every would-be client, charge the client for research to familiarize themselves with the salon’s particular legal problem, and thenfail. The salon owner should choose a lawyer who has both the time and willingness to sit down and discuss legal matters. A great lawyer, even one particularly knowledgeable about the beauty industry,who is difficult to reachis worthless. Closely related to availability is dependability. Make sure that the attorney chosen to handle the salon’s legal problems can follow through on any problems that may arise. Lawyers, aRer all, are selling a service. If that lawyer cannot provide those services on time and in good order, at a price consistent with its value, keep looking. It is also extremely important to understand the attorney’s fee schedule since this is the biggest area of misunderstanding between clients and their attorneys. In fact, it is best to have any agreement in writing. A written agreement with a lawyer will avoid a lot of misunderstandings later. Naturally, if excellent legal advice is desired, salon owners must expect to pay forit. And payfor it they will. But, once again, shopping for a good, knowledgeable, and economical attorney is good advice to both new and established salon owners. Insurance Agents and Brokers

In today’s “sue happy” society, every salon owner knows that insurance is an important part of doing business. Angry suppliers, tightwad landlords, dissatisfied patrons, even the individuals who might trip over a crack in the sidewalk in front of the salon will oRen sue assoon as talkto the salon owner. Knowing what kind of insurance coverage is necessary for the salon, where to obtain that insurance, and, of course, being able to afford adequate insurance coverage are all issues that

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must be addressed by every salon owner. Here, too, dealing with a professional doesn’t cost, it pays. Some insurance consultants expect to be paid for their advice, but another type of professional frequently offers invaluable advice in the hope of selling that insurance coverage: an insurance broker. Although the difference is sometimes difficultto see, an insurance agent isusually the employee of one insurance company that may or may not offer all the coverages desired or needed by the salon. An insurance broker, on the other hand, frequently represents a number of different insurance companies. Insurance brokersnot only advise about desirablecoverages but are ina position to search among thecompanies they represent for the best coverage at the lowest price. Both the independent consultant and the insurance broker can suggest strategies that will help the salon operation reduce the cost of insurance coverage. Insurance brokers, obviously, are interested In selling insurance. Their income comes from commissionson the policies they sell. But brokers offer an important service every bit as valuable as those provided by the salon operation’s account or lawyer. In addition to offering a variety of insurance companies and coverages from whichthe salon owner can pick and choose, independent insurance brokers are also well aware of the financial health of the insurance company. Lloyds of London, one of the premier insuranceunderwriters(they,in essence, insure the insurance companies) has in recent years suffered tremendous losses. In theUnited States, many insurance companies are also troubled. A broker has theindependence to steer thesalon owner or manager to a reliable and solvent insurance company for the coverages needed. Insurance is much like realestate in that at times it seems that everyone is trying to sell it. But, friendship is not a good reason to pick an insurancebroker or ever a reason to choose an insurance agent rather thana broker. Independence is a virtue that increases in value with experience. And insuring the salon is business.

CHAPTER FOUR

Banking Relationships

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Nothing is more difficult forthe average salon owner or manager than toobtain financing for the beauty-related businessor operation. That is, nothing is harder to find than affordable financing for anything as foreign to a lender as a business that is in any field not considered basic. Fortunately, there isat least one way to ensure that a request for a loan will get a full and fair hearing. The route most salon owners are familiar with is to simply fill out a loan application for submission to aloan clerk. But business owners/managers who dutifully complete loan applications at their neighborhood bank are, at best, limiting their options. They will either get those needed funds at a price that can only be compared to paying “retail,” or they will be turned down and have to begin the whole application, documentation, and interview process anew at another bank. Experienced salon owners or managers often ignore the loan application altogether-and often even ignore banks-to get the money they need at a price they feel the salon can afford. The tool employed most frequently is a so-called loan package. THE LOAN PACKAGE

A loan package provides all of the factual information normally contained on a loan application. But a properly prepared package also provides ample opportunity to expand on just why the funds are needed, how they will be repaid, and other pertinent information. Relevant financial data can be expanded upon or explained far beyond the bare-bone statement of facts and figures asked for on a loan application. A complete explanation of how the salon works, where it fits within the industry, and its potential can be included in a wellprepared loan package. Plus, with a loan package in hand, it is possible to obtain funds from a variety of sources, not just a bank. To best understandhow a loan package works, salon owners or managers must know who they will be dealing with in their search for money. First, most of the people with whom they

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come into contact will be employees. Making an appointment in advance will usually ensure thatyou deal with a bankofficer rather thana loan clerk, but that individual will still be an employee. As employees, they haveno personal concern about the money involved. It is not their money and therefore they have no vested interest init. But theydo have a seriousconcern about their jobs and theirpromotions, and these are tied to how well they handle their employer’s funds. So in almost every case, their first concern is how lending or investing in a given situation, even one like thesalon’s, will make them appear in the eyes of their superiors. Security

It is obvious whythe salon owner or manager seeking funds for any purpose other than the most mundane will have a difficult time. After all, every lender is looking at the downside risk; the salon owner or manager is looking at upside potential-r should be. A lender isconcerned with safety to a higher degree than aninvestor, but neither wantsto lose money.So the first key to any successful loan package is security for the funds that arerequested. Profitability

The second factor is profitability to the lender or investor willing to provide the funds. Remember, though, that the rateof fund profitability for the bank or lending institutioncomes not only from the direct returnproduced by the use of the funds butalso from fringe benefitsas a result of providing those funds. A good example of this is provided by a banker who looksat a business loanas a way of creating aprofitable customer for his or her bank. The discounted interest rate normally offered to bank customers is one example of the way bankers view loans. Surprisingly, the rate of return on the loan requested is not nearly as important as the futurebenefits that loan might create for the bank.

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If the bankerviews the beauty-related business as a growth situation where the account will get larger, the loans become bigger and more profitable, the salon begins utilizing more and more banking services and, eventually, becomes a highly profitable account for the bank, he or she will take more of a chance than might be the case if it was simply an in-out proposition with little in the way of future prospects. With investors, the same principle holds true. A “kicker” or other arrangement thatgives an investor an opportunity to realize more than a basic dividend return will usually make obtaining fundsfrom this source a lot easier. So in addition to spelling out the security that will be provided the lender or investor, the loan package allowsthe salon owner or manager to remind the lenderhnvestor of the future benefits that will follow if this proposition is approved. This information rarely has a place on a loan application. Repayment

The nextquestion that mustbe addressed in every loan package is how the money will be repaid along with profit to the lender/ investor. This iscritical. If the lendedinvestor can be assured of repayment-with a profit-then the problem comes down to a question of amount and terms. Lenders are primarily interested in learning whether the borrowed funds can be repaid out of the operation’s cash flow. Thus, including a cash-flow projection in the loan package provides a quick answer to this question. No short-term lender such as a banker will put up funds that can only berepaid from profits. That is the field of the longterm lender or investor. The short-term lender wants the money from cash flow regardless of whether there are anyprofits. When it comes to investors, it is usually understood that their returnscome fromprofit, or from the sale of their holdings to others contemplating greater profits in the future. The loan package aimed at a lenderwill differ in the matterof repayment from one that is aimed at a potential investor.

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PU'ITING THE LOAN PACKAGE TOGETHER

Putting together a loan package with the help of an accountant or lawyer is relatively simple, and no one format is better than any other. A number of professionals also specialize in the preparation of such packages. Experts advise avoiding those who promise a package and/or results, in exchange for an up-front fee and a percentage of the funds obtained. Lenders and investors normally prefer to deal with principals not third parties. The final package will always address three critical points. 1. Safety: Lenders must be assured that their funds are safe. They want to see collateral, consignors, and subordination of previous debt to assure thesafety of their money. 2. Profitability: Lenders are interested inthe best rate of return on this loan plus future profits fromfurther dealings with the borrower. By showing lenders more income for them down the road, any borrower greatly increases his or her chance of getting theoriginal loan. 3. Repayment: As verifiable proof that the use of the funds will generate the necessary cash for repayment within the allotted time for the loan, the package should contain an accurate use-of-funds statement as well as a projected cash-flow statement showing how the use of the funds by the business will produce the necessary cash flow. These assumptions must be supported or backed up with reasonable proof that can be verified from other competent sources.

The loan package takes many different forms and shapes and contains widely varying amounts of information. Boiled down, however, the loan package provides all of the information usually contained on a loan application but presents it, and any other relevant additional data, in a manner designed to influence, inform, reassure, and even educate the potential lender.

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With a loan package in hand,salon owners or managers can approach bankers with confidence that theirrequest will receive the attention it deserves, even if the banker knows absolutely nothing about that particular type of business. Best of all, regardless of how exotic,unusual, or risky the business, salon owners or managers are not limited to making their requeststo one bank or even a numberof banks. SOURCES OF FUNDS

There are manydifferent sources of funds, all looking forviable propositions, lending, or investment situations. The loan package provides a professional method of applying for those funds. Imagine using aloan package to approach the following: Bankers Commercial finance firms Savings and loan institutions Real estate brokers Pension fund managers Insurance company investment agents

Venture capital firms Factors Private investors Mortgage bankers Stockbrokers Foreign sources

Somewhere there is a lender or investor looking for a business in need of funds. A professional approach, utilizing a comprehensive loan package, just might be the key to tapping those funds for use in your own business. It might also go a long way toward obtaining preferential interest rates, if there is such a thing today. Unfortunately, in the searchfor capital many salon owners and managers overlook the most important factor: repayment. After all, everyone can use more money. The question that must be addressed is whether the borrowed money can be repaid or will pay for itself by increasing the salon operation’s net income. Thus, it is necessary toborrow smart.

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BORROWING SMART

If someone were tooffer the average salon owner a giR of $10,000 with the choice of having it now or next year, most would elect now. Most of those who want itnow would be making the right decision without being aware of it. To phrase the question differently, if the samesalon owner knows he or she will need $10,000 next year, how much should be invested today? The answer, of course, depends on the return on investment ratethat the salon can command. Ifthe salon can get 10 percent, then investing $9,090 now will yield $10,000 a year from now. In a nutshell, that’s discounting cash. Having $9,090, the salon owner can invest it at 10 percent for a year, which is the same as having $10,000 a year fiomnow. Conversely, borrowing that same $10,000 now means paying back $11,000 next year. Naturally,if that $10,000 is needed to make the payroll or to keepthe operation afloat,no cost is too much. But under normalcircumstances, can the salon afford to pay $11,000 back next year? Orwill the $10,000 invested in the business produce a profit of 10 percentor more? If the salon operation is showing a return of 5 percent of income, it will have to increase that income by $20,000 merely to pay the 10 percent intereston a $10,000 loan. Will investing that borrowed $10,000 increase the salon’s income enough to repay that debt? If the borrowed moneyis needed for survival or if the return will justify borrowing it, theobvious question, at least for a smart owner or manager, is whereto borrow the needed hnds. Types of Bank Loans

As already mentioned, the first step for most salon owners and managers is usually the bank. But remember, arranging the wrong type of loan for your salon can make life a terrible hassle. Although short-term loans fit a banker’s normal way of thinking, they arenot alwaysin theborrower’s best interest.The fact

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is, many good reasons for borrowing can be the result of situations that cry out for intermediate- or long-term repayment plans or even alternative types of financing. Businessfrequentlyincreasesfaster than profits and/or retained earnings. If the sales spurt is temporary, because of seasonal demandsfor instance, then a short-term loan is what is needed. If the rapid growth is expected to continue for a long time, however, what is really needed is a continuously expanding lineof credit. Normally, a move into a new market does not yield shortterm repayments. Bankers usually evaluate the current profits of the salon to see how long it will take to pay off an unsuccessful venture. On that basis, it is often possible to negotiate an intermediate-term loan, sayfrom twoto seven years. When it comes to new fixtures or equipment, if it will reduce the current overhead of the salon, then the repayment can be tied to current profits plus the projected reductions of overhead. Ordinarily, the banker will limit the termof the loan to just less than expected the life of the equipment.The answer is to match the repayment to the anticipated change in cash flow. Even though most salon owners and managers can arrange a long-term loanover seven years, based on the long-term value of real estate andbuildings, that is not necessarily a good reason for long-term borrowing. If the salon operation is growing fast, it may not be wise to tie up money in a building that may soon be outgrown. Long-term loans should befor stable, mature operations with steady earnings that arenot likely to expand again in the near future.Otherwise, the salon may be better off leasing space with an option to expand or move, keeping cash for growing inventory, accounts receivable, and the like. As a general rule, bankersdo not like toloan new money to any business in trouble. However, if the salon already owes them money, they maybe receptive to providing more, so long as the owner or manager knows what the problem is and is doing something to correct it. But, remember, the bank is not the only source of new funds.

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Private Investors

Next to banks, private investors of one sort or another are the major source of long-term financing for small businesses. Very oRen a private investor sets priorities very differently than a bank. This can mean a deal that has no attraction a t all for a bank will look very good for a private investor. Thereare all sorts of privateinvestors willing to loan money. They range from friends and relatives to professionals who make their money by making loans to small businesses such as salons. Some private investors can be very good partners and some of them are nothing but trouble. It is extremely important to know who you are dealing with and what their motives are before any deal is made. Some types of investors are too expensive no matter how badly the money is needed. Finding a private investorcan be easy. Many professionals advertise in newspaper classified ads or the financial section. Some are listed in thephone book. Others will be knownwithin the business community. But, remember, the salon operation can expect to pay at least prime rate to a private lender and sometimes a good bit more. Government Programs

It may surprise many salon owners and managers to learn of one relative who has large amounts of money to invest. That relative, Uncle Sam, is just the tip of a government iceberg that stretches from the local economic development office to the state government and up to many federal agencies, the best known of which is theSmall Business Administration(SBA). Just look at the numbers. According to the Washington, D.C.-based Corporation for Enterprise Development, all but four states now provide sometype of small-companyfinancing; twentyeight offer publicly-funded venture or seed capital. Twenty-five states fund new business incubators designed to help start-ups through the difficult early stages. Forty-six states have Small Business Development Centers to provide management assistance. Thirty states award grants for state-of-the-art research and development.

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This surprisingnumber of programs directed at helping small business didn’t exist ten years ago when only a few states even had small business offices. Economic development mostly meant persuadingbig companiesto locate (or keep) their facilities in a given area rather than move to another. Such “smokestack chasing” is still common because the political allure of landing a big plant is too much for most politicians to resist. But many states and localities are beginning to realize that helping small, indigenous companies growis a wiser use of public resources. Obviously, the best information about government programs a t all levels comes from others with firsthand experience. Starb ing from scratch, to locate state programs there are two directories. The States and Small Business: A Directory of Programs andActivities,1989, is a 411-page directory of state listings available from the Small Business Administration for $12. Directory of Federal and State BusinessAssistance, 1988-1989: A Guide forNew and Growing Companies(NTIS Order NO. PB88101977) is a 170-page directory published by the US.National Technical Information Service for $29 plus $3 handling. In addition, more than half of the states now have small business offices, toll-free hotlines, or small business advocates. If your state doesn’t, call its Department of Commerce or Economic Development Department. The state government will not tell anyone about local programs, which are often the easiest at least for most salon owners or managers to approach for financial assistance. Mergers, leveraged buyouts (LBOs), takeovers-never before has it appeared that so many have borrowed so much from so many sources. Where is all of this money coming from? We’ve pointed out a few sources that the average salon can tap including approaching a bank for more than short-term financing. But foreign capital, pension funds, money markets, public offerings, junk bonds, and the like are not realistic sources of capital for most salons. Still the country is awash in money. But one word of warning: manysalon owners and managers feel buried under a mountainof debt. Few of them, however, can actually say whether they are making or losing money on the

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funds that they borrow or precisely how that debt would have to change in order to reach a manageable level. Thus, many avenues are open to finance both the smallest and largest, newest and oldest salon. There is an abundance of cash that any owner or manager with agood business plan and a fairly good credit record can tap. However, in addition to worrying about getting that money, a really astute salon owner or manager is aware of how much that borrowed money will cost, how much income must be increased to pay for those borrowed funds, andhow much thoseborrowed funds will earn. Failureto know anything less can meanmoney-losing a business awash in debt that cannot be repaid. WHAT MONEY COSTS

Once business owners or managers have a basic understanding of the financial picture of their own salon operation, the next step is not only to understand but to be able to deal with the numbers of the borrowed money. Coping with interest costs is not an easy task, but the experts have developed a number of successful strategies for comingto grips with today’s interest rates. For instance, many successful salon owners and managers have discovered that a good first step toward coping with interest costs is to understand just what that borrowed money actually costs. Oh, sure, the interest rate may be clearly stated at a certain percentage, but how much will the salon have to increase sales to maintainthe present profit level? Obviously if the salon must pay $1in interest costs, it will have to take in considerably more than that $1 in additional sales if it hopes to keep its bottom-line profits at the same level as before the money was borrowed and an interest expense incurred. In other words, you may have to increase your sales by as much as $10 to pay that $1interest cost if your net profits are only 10 percent of gross sales. You can calculate just how many additional dollars in sales are required to break even with the interest cost of borrowing

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money by employing a simple formula. This common rule of thumb simply involves dividing the interest cost by percent of gross profit on net sales. For example, suppose youborrow $100,000. Using the formula, at a 10 percent annual interest rate and gross profits that are 25 percent of net sales, the computation would looklike this:

* oo’ooo

25

x

O% -

* ’o’ooo 25

“ -

$40,000 additional sales needed

This same computation also works in a variety of other important business decisions. For example, it can be used when you, as thesalon owner or manager, areconsidering whether to add another person to the payroll, or to increase inventory, or whenever you are thinking about acquiring new equipment or fixtures. Obviously it is a good formula to know and use before making anymajor purchasing decision. With it you will at least have some ideaof how many more salesdollars will beneeded to maintain the presentprofit level. Increased utilizationor better “working”of assets is another way of coping with interest costs. In fact, making assets work harder is a very good way toreduce the need for borrowedfunds. An important financial ratio that can tell anyone whether available funds are now being used as well as they have been in the past is known as the net-sales-to-working-capital ratio. You may never have used the net-sales-to-working-capitalratio before but you can be sure that any lender you approach is going to be interested. Working Capital

Working capital is nothing more than the difference between your current assets and your current liabilities. This working capital is the framework on which your business operates. Just as the bones in a person’s body support a certain number of pounds of flesh without medical problems, so the working capital thatis available can support agiven number of dollars in net

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sales without financialproblems. So the working capital that is available can support a given number of dollars in net sales without creating critical financial problems in the business. If you exceedthe capabilities of your working capital framework in net sales, you can expect to have inventory, receivable, and accounts payable problems in addition to severely limited-or nonexistent-net profits. One easy way to determine whether the salon operation is using working capital as well now as atother times inthe past is by means of yet another of our simple formulas. In order to find the netsales per dollar of working capital, you simply divide net sales by the working capital shown on your balance sheet. Comparing theworking capital available, the net sales, the net sales per dollar of working capital, andyour net profits for each of the last ten years will give you an idea of the point at which your business was bestable to support net sales profitably. REASONS FOR BORROWING

In addition to formulas for determining how much you must increase your sales inorder to pay for borrowed moneyand how efficiently the salon operation is using its present assets, there are also several nonfinancial controls that can help youcope with today’s high interest rates. These three controls can be used by almost any business owner or manager. And best of all, no figuring is involved. All that is necessary is to evaluate the urgency of borrowing. There are threebasic decision-making categories, each unique in its own way. 1. I want this now. If it is simply a borrowing need that is wanted now, but can be put off, then it falls into the first category and money is not borrowed for this purpose. 2. I should get this equipment or fixture or hire more employees, but with money so tight, I can actually get along without it. A deferred purchase, so long as itdoes not lower quality,

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raise costs, or increase timeto get a job done may be a more profitable choice than buying now with the present cost of money. 3. I must havethis money now to meet payrolls and pay bills. The so-called must-have decision is the one that leads to borrowing no matter how high the interest rates maybe. It is in response to a crisis and is not reallya choice.

All too often wetend tooverlook simple solutions to business problems. Determining the absolute need for borrowing by deciding on the urgency first through this three-step decision-making process can frequently eliminateexcessive, expensive borrowing. Cash-Flow Planning

Another tactic involves cash-flow planning. Cash-flow planning lets the salon owner know months ahead when money will most likely have tobe borrowed. A cash-flow plan sheet showing anticipated sales and expenses by month, adjusted as the months move by, is an excellent management tool for telling just when extra money will beavailable or when more money will probably be needed. In working with a cash-flow projection, it is often useful for the salon owner to show cash and expense totals according to profit centers.Some typical profit centers may be supplies, hair washing, styling, manicures, or tanning. The purpose of this extra detail is to know when extra management effort may be required to keep cash flowing as planned. Employee Productivity

Employee productivity in any business also has a great deal to do with the need to borrow money. Low productivity invariably leads directly to high costs. However, low productivity doesn’t always start with employees. Remember, employees only carry out andreflect the attitudes of management. Generally, in order to raiseproductivity, management must often share information about the present status of the busi-

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ness, set goals that are reasonable, and, above all, help employees achieve those goals. For example, you may show the employee a breakdown of his or her productive and nonproductive hours to encourage more productivity or morebookings.Oryou may reveal operatingexpenses per employee-hour figures to help create cost consciousness. Borrowing money has always been an acceptable part of doing business and will continue to be so. However, money is a commodity just like inventory or services used in the salon business. The cost of money rises and, occasionally, falls with demand. The demand influences the prime rate. So obviously, controlling the salon’s need for money can helpavoid borrowing at a time when interest rates are high or the money is not really needed. As already mentioned, one of the advantages of using a cash-flow plan is that salon owners or managers can use it asa reason to visit theloan officer of the bank where they do business about every other month. The cash-flow progress can be discussed. As there are definitely more favorable times to borrow than others, a commercial loan officer can show you when you might savemoney by borrowing. FINDING A BANK

The commercial bank is usually the first, longest-lasting, and most intimate capital supplier to a salon. Unfortunately, few salon owners or managers thinkof their banks as anything but a capital supplieror processor of checks. But there is much more to bankingthan simply checks and loans.

Bank Services We are all aware that our bank offers checking and savings accounts. Thanks to this service it is possible to deposit the checks received from our customers and have the amounts credited to our account. Similarly, we can write our own checks using the money in that account to pay our own bills. Those

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checks will generally be accepted by anyone regardless of where they conduct their bankingbusiness. Your banker will usually perform a credit check that will enable the salon to determinejust how much credit to extend a customer, how reliable a supplier may be, or even how financially solvent a job applicant may be. The ever-neutral banker will also perform these credit checks or supply credit informationon any firmor individual, customerof that bankor not. To help make the decision of whether to add extra employees, that same bank can also provide local or regional economic data that is usually quitereliable because of the bank’s unique position as a financial confidante and intermediary for a variety of local businesses. And just imagine utilizing this resource in the mergerand acquisition field. Banking services usuallyencompass a merger and acquisitions specialist or department that can do anything from finding a suitable candidate for a merger or acquisition to actually negotiating a mutually satisfactory deal. Among the most common services a bankcan offer, however, is theuse of its money in theform of short-term capital.Of course, to most salon owners and managers short-term capital simply means a loan. But it can also take other forms such as leasing, credit card or merchant chargeplans, or the factoring of accounts receivable, all of which help freethe salon’s capital andare usually offered byyour neighborhood commercialbank. And don’toverlook the largest short-term capital need of all-the payroll. Banks have the computerresources, the skills, and the money to take care of the salon operation’s payroll accounting. Depending upon the relationship, in fact, that same bank may advance the payroll funds needed to pay the employees and even file the necessary tax andinformation forms and reports. Banks also offer a varietyof other accounting services as well, including demand deposit accounting, installment loan accountr ing (andcollection),mortgage loan servicing and accounting. A bank thatoffers revolving credit loansor term loans could be said to be entering the intermediate-term financial arena, closer to long-term financing. That is the trend today as banks press up against thecongressional limit on long-term financing

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and securities dealing. Banks continue to develop moreand more services that utilize their computer and personnel resources, all of which are designed to attract more customers to that bank. This volume of services obviously benefitsthe small or mediumsized salon, or at least those whose owners and managers are aware of the amazing number of services that a bank is willing to perform. But banking benefits don't stop withthe salon. Owners and key employees can also profit fromthe banking relationship. Banks routinely offer preferential interest ratesto the owners and keyemployees of its business customers. "rust services, retirement plans, financial planning, or even a free safe-deposit box all make desirable fringe benefits for attracting and retaining key employees,as well as for the operation's principal or owner. Just as the so-called prime rate is merely a guide to interest rate levels and is usually negotiable, the many services offered by the average bank are also offered by another bank justdown the street.In other words, competition exists between banks all attempting to get your business. Although it might help to be the largestsalon in the area,most banks aremore interested in the amount of money they can realize by doing business with a given salon than the actualsize of the operation. Obviously, the more services a bank performs for the salon operation, the more the bank will value the operation as a customer. The betterthe customer, the less the bankwill charge for its various services. And, no, those bank services are never free despite thebank's advertising. Fortunately,the amount paid for everything from a checking account to aloan is negotiable, if not at your present bank thenat the next one you approach. Paying for Banking Services

When it comes to paying for those banking services, two widely differing schools of thought exist. Some experts believe that a salon owner or manager should know the exact amount being charged for each service utilized and pay accordingly. Other experts believe in trade-offs best illustrated by the everyday checking account.

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Some banks charge a flat 1Oq per check written, 7q for every check processed,25G per deposit and, perhaps, a bookkeeping fee of $10 per month. Other banks loudly proclaim that they charge no fee in returnfor the customer maintaining a minimum balance in the account at all times. Of course, with both methods, the bank usually fails to mention the profits it earns on the funds that itreceives for cleared checks, which isn’timmediately available for the salon to use. This float is a significant amount as recent congressional hearings haverevealed. Although the float (the money the bank earnson funds inits control but not used by or available to the customer) is significant; the average owner or manager would be wiser to concentrate on how much the banking services actually cost out-of-pocket. For instance, if yourbank offers free business checking in returnfor a minimum $1,000 account balance, the salon owner or manager must compute how much the operation could realize if that $1,000 were invested. This, then, is what that “free” checking actually costs. Similarly, low interest rates offered in exchange for minimum balances require this same computation. To compare the cost of these “free” checking accounts with the cost of one that imposes flat fees for each deposit or each check drawn, the average volume must be computed. Thus, weekly deposits or ten checks written each week costs X dollars opposed to the interest lost on the funds required to maintain the minimumbalance requiredfor a “free”checking account at a competing bank. This bank comparison applies to every service offered by banks. What does each service actually cost in either hidden or up-front fees? The comparison not only tells owners the actual price of their banking, but also provides invaluable ammunition for negotiating with those bankscompeting for your business. Bank A might offer an interest rateof X percent to anyone who applies. Customers might be offered an interest rate of X minus 1 percent. A customer who also uses-and pays for-the bank’s payroll accounting service might be able to ask for an interest rateof X minus 2 percent. All banking services are negotiable. If your present bank will not discuss its rates, the one down the street will. If the

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salon is paying too much for banking services it can usually be attributed to ignorance. Few of us actually know what we are paying for bank services, particularly in those hidden costs. Shopping or negotiating for neededbanking services has several otherbenefits. First, it helps demonstrate just how many services commercial banks actually offer. It also brings the owner, principal, or manager closer to the operation’s bank. And that banker isthe key to a profitable banking relationship.

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CHAPTER FIVE

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As already mentioned, one of the more important professionals that any salon owner can count on is one knowledgeable about insurance. Usually an insurance broker, an individual or firm, represents a numberof insurance companies. From these insurance companies, the broker can choose the company and theproducts and policies that the salon requires and can afford. These two requirements areinterchangeable. Certaintypes of insurance are necessary to ensure the financial well-being of any salon. There are other types of insurance that are quite desirable but perhaps optional in light of their cost. The insurancebroker can help determine which types of insurance coverages are mandatory, which would be beneficial, and which are luxuries considering the financial picture of the salon. HEALTH INSURANCE

First consider one insurance that is rarely affordable and yet is one more and more employees and salon owners are looking for the salon to provide at little or no personal cost: health insurance. Regardless of whether Congress eventually requires that employers pay the healthcare premiums,or a portion of them, of their employees, there are a number of health insurance programs that arelegitimately tax deductible by the average salon. In essence, this tax deduction could be best compared to Uncle Sam, in theform of the IRS, picking up a portion of the tab for providing health insuranceto salon owners and theiremployees. According to the health insurance industry, the average hospital stay is 7.6 days and costs, just for the hospital, more than $2,800. With hospitalcosts averaging inexcess of $370 per day, it is little wonder that more than 192 million Americans82 percent of the civilian noninstitutional population-are protected by one or more formsof private health insurance. Medical expense insurance ismerely a “reimbursement type” of coverage that provides broad benefits that can cover virtually all expenses connected with hospital and medical care and related

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services. Disability incomeinsurance provides periodic payments when the insured is unable to work as a result of sickness or injury. Costs and Tax Rules

Unfortunately, the cost of accident and health insurancecoverage has more than doubled in the last five years alone, thus placing it out of the reach of most individuals. Enter Congress, which has made health insurancea legitimate business deduction-subject to the usual variety of rules and regulations, of course-for all employers. What types of health insurance are usually offered as fringe benefits by salon and other beauty-related businesses? The list includes:

.. .. 9

Hospital expense insurance Surgical expense insurance Major medical insurance Disability income protection Dental expense insurance

According to our tax rules, all amounts paid by an employer to improve the well-being and morale of employees and that directly benefit the salon’s business by inducing low labor turnover, absence of strikes, and increased loyalty are tax deductible as ordinary and necessary business expenses. Thus, contributions made by a salon to accident and health plans or even disability benefits paid (through insurance or otherwise) to employees, or payments such as those for medical care, permanent injury, or compensation for loss of wages, in reasonable amounts, are fully tax deductible. Of course, such deductions are limited to the amount not compensated by insurance or otherwise. The employee’s gross income does not, at least for federal income tax purposes, include any amount for these accident and health plans. In other words, employer contributions to an

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insurance company for employee health and accident benefits are generally not taxableto the employee-including the salon’s owners, officers, and anyexecutives. Benefits paid, whetherfrom an insured planor a self-insured plan, are also generally not included in the employee’s gross income. Naturally, as with everything in our tax rules, there are exceptions. Benefits can be included in gross income, forexample, where a sick or injured employee incurs medical expenses in one year, claims a medical expense deduction for the expenses, and receives reimbursement in a succeeding year. They can also be included in the employee’s taxable income if they result in excessive reimbursement (i.e., if they exceed the amount of the medical costs). In such cases, the excessive indemnification is included inthe employee’s gross income to the extent that it is attributable to employer premiums or employer contributions. If any part of the excessive indemnification is due to employee-paid premiums, it is apportioned according to the respective amounts paid by the employer and theemployee. It is estimatedby the experts that some 39 percent of the total insurance company group coverage is represented by Administrative Service Only (ASO) arrangements and Minimum Premium Plans (MPP). Under thesesystems, salon chains and otherorganizations usually establishself-funded health plans. Insurance carriers or private organizations are paid a fee by the self-funding group to process the claims and benefits paperwork. Under MPP, many employers also insure againsta certain level of large, unpredictable claims. Excessive Reimbursement

Unfortunately, there arecircumstances where the employee of a salon may actually be taxed on the benefits received from the salon’s self-insured health or accident plan. If an employer has a plan that discriminates in favor of a so-called highly compensated individual, the benefits paid under that plan are included in that individual’s gross income to the extent that they constitute “excessive reimbursement.”

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Under our tax rules, a “highly compensated individual” is anyone who comes within any of the following classifications established by our lawmakers: 1. An officer among the five highest-paid officers in the incorporated salon business 2. A shareholder who owns more than 10 percent in value of the employer’s stock 3. An employee among the highest-paid 25 percent of all employees

When it comes to determining the shareholder classification, the stock attribution rules apply. Under the infamous stock attribution rules, stock owned byan individual’s spouse, children,parents, or grandchildren is attributed to theindividual in applying the more than 10percent stock ownership test. If an executive or otherhighly paid employee receivesa reimbursement that is not available to other employees, the entire reimbursement is an excessive reimbursement that is fully included in the income of the employee although still deductible by the salon. However,if the plan merely failstomeet the requirements already discussed, excessive reimbursement (i.e., the amount that would have been includedin thegross income of a highly compensated individual) is determined by a simple formula. To illustrate, consider Nonsense, Inc., a three-salon beauty chain that has a self-insured medical reimbursement planfor its employees. The plan paysthe medical cost of all participants. In addition, the plan provides a $100 per day “supplementalliving allowance’’ forany officer of the incorporated salon chain. During the tax year, the corporation’s executive vice president was injured in anautomobile accident and hospitalized for twenty-five days. His medical bills for that period of hospitalization totaled $4,800. His absence fromwork totaled eighteen working days and he received a total of $1,800 for this absence period. Overall, for that tax year, the plan paid a total of $40,000 in benefits, $10,000 of which constituted benefits paid to socalled highly compensated individuals. The amount of excess

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reimbursement that the executive vice president had to include in his gross income for that year was the $1,800 supplemental living allowance plus $1,200 of the medical reimbursements ($4,800 times $10,000 dividedby $40,000) for a total of $3,000. Generally, the taxdeductible accident and healthplan contributions include all payments made by employers to any sickness or disability fund maintained under astate disability benefit law. An employer’s payment to an irrevocable trust in order to fund a voluntary employee benefit association (VEBA) plan for the payment of medical coststo its eligible employeesis taxdeductible. What’s more, in those situations where a lump-sum payment is made to workers’ compensation in order to withdraw from the fund and become self-insured, it is also tax deductible. However, expenses paid or incurred by an employer for a group health plan are not tax deductible if the plan differentiates in the benefits it provides to persons with end-stage renaldisease. When it comes to medical expenses paid by an incorporated salon operation under a plan limited to a stockholder-employee, these are deductible only as compensation. Similarly, medical payments made pursuant to an employment contract are deductible as compensation. However, medical expenses paid by a controlled corporation on behalf of an officer-shareholder are excludable from the officer’s gross income and deductible by the salon corporation even though the plan does not provide equal medical coverage for non-shareholder employees. When the salon pays the costs of rehabilitating one of its executives at a resort hotel or at anathletic club, such costs are deductible, but only if they are treated as compensation and if the reasonable compensation test ismet. Generally, however, a salon’s contribution to accident and health plansfor compensation (through insurance or otherwise) for employees, their spouses, or their dependents in theevent of personal injuries or sickness are not taxable to the employee. This exclusion applies regardless of whether the employer’s contribution is made by payment of insurance premiumsor by some other means such as self-insurance or reimbursements made directly to employees who have paid the premiums themselves.

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Although the taxlaws and regulations often refer to “plans,” an accident and health p l h d6eg not have to actually meet any specific requirements. A plan can be of the nonfunded or the funded type and can either be insured or noninsured. In fact, it is not even necessary that the plan be in writing or that the employee’s rights tobenefits under the plan be enforceable. However, if a plan is not in writing and the employee’s rights to benefits are unenforceable, an employee must, asof the date of sickness or injury, be covered by the plan, and notice or knowledge of the plan must be available. No plan was found to exist, for example, in one situation when theemployer could cite only one previous instance inwhich an employee had been paid while he was absentfrom work because of illness. Aside from the controversial health insurance, today it is possible to get insurance against virtually any potential no risk, matter how far fetched. However, as already mentioned, few salons can afford insurance coverage of that magnitude. Many salons, in fact, are lucky that they can afford to insure against any risksat all. TRADITIONAL INSURANCE

If insurance dollars are short, consider a few of the most important types of coverage and ways to reduce even those essential premiums. Liability Insurance

According to the experts,liabilityinsuranceis an absolute necessity. What’s more, that liability insurance should cover as much as 95 percent of the salon owner’s maximum personal liability. Today this means at least $1million, probably more in light of recent damage awards. Most liability insurance policiesnowcover, in addition to bodily injury, personal injuries such as libel and slander, butonly if they are specifically mentioned in the policy. And if there are employees, agents, or independent contractors working on the

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operation’s behalf, the salon can be held liable for their actions, at least in some circumstances. This risk is insurable, necessary, and usually quite expensive. But not as expensive as the potential consequences ifthis insurance isnot carried by the salon. In this and other areas, one way in which to get maximum amounts of coverage for an affordable amount is to self-insure some of the risk using deductible policies. In other words, the salon agrees tobe liable for up to $500, $1’000, $5,000, or more, and the insurance company pays any amount over that. This permits higher amounts of insurance to be purchased for maximum protection. Fire Insurance

Fire insurance is essential, and insurance against other perils such as windstorms, hail, smoke, vandalism, explosion, flood,and malicious mischief can usually be added to the basic fire insurance policy for only a small additional premium. In fact, many salons employ a comprehensive coveragepolicy, an all-risk policy offering the broadest possible coverage relatively inexpensively. After all, the total premium is usually less on an all-risk policy than for separate coverages. Settling Claims

Insurance companies offerseveral alternative methods for paying the salon’s losses, something of which everyone should beaware. That’s right, inaddition to seeking the right andnecessary coverages at the rightprice, the salon owner or manager must also be aware of the insurance company’s policy onpayouts. The insurance company’s method of settling claims may not be what thesalon owner wants or what is best for the salon operation. The insurancecompany may pay the actual cash value on the property at the time of the loss, they may prefer to repair or replace the property with material of like value, or they may take over the remaining property and pay for all property (damaged and undamaged) in one lump sum.

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Even though some salon owners and managers feel there is no such thing as too much insurance, remember you cannot overinsure andbe paid an amount that exceeds the value of what was actuallylost. Insurance companies combineto pay off only a percentage of the value of the loss. They do not pay full amounts independently. OTHER INSURANCE

An automobile insurance policy should cover employees, contractors, and agents acting on your behalf even ifthe salon operation doesn’t own the vehicle they drive. Five or more vehicles are all that are usually required in order to qualify for low-cost “fleet” insurance for damage to both the vehicles and to people and other property. Once again, self-insurance in the form of higher collision deductible amounts helps reduce premiums. Extra coverage such as uninsured motorist and medical payment insurance for all parties to an accident can, however, quickly eat up any savings from larger deductibles. Business interruption insurance can be essential in some cases and optional in others. Generally, the business interruption policy provides payments for amounts spentto get back into operation. There is also coverage available for increased costs due to the partial interruption of a business. These policies can also include reimbursement for losses due to failure or interruption of light, power, heat, gas, or water that is furnished by a public utility. Other desirable, but not really essential, insurance coverages include policies such as crime insurance. If extra funds are available, a comprehensive crime policy forsmall businesses, one that covers burglary, robbery, and other types of losses by theft (including theft by employees), is usually the most economical. If the business is located in a“high-risk” area where no commercial crime insurance is offered, the U.S. Department of Housing and Urban Development offers a unique government-backed plan.

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Primer

Separate burglary insurance normally has certain exclusiom+ accounts, valuable articles in a showcase window,and others. When checking to see that insurance covers those areas, it should also be remembered that a policy can be written to cover the contents of a safe, inventoried merchandise, and even damage incurred in the course of the burglary. Robbery insurance protects against the loss of property, money, and securities by force, treachery, or threat of violence on or off the business premises. Surprisingly, few insurance policies cover glass, requiring a separate insurance policy. A special glass insurance policy can be purchased that covers all risks to plate glass windows, glass signs, motion picture screens, glass bricks, glass doors,showcases, countertops, and insulated glass panels. But coverageshould cover costof not only the glass but also the lettering andornamentation as well. And, don’t forgetthe cost of boarding up when necessary. OWNERS AND EMPLOYEES

When it comes to insurance coverages, there areemployee benefit insurance programs such as group life insurance or the health and disability insurance coverages already mentioned. These generallyfall into thecategory of fringe benefits, not true insurance. Oneexception to this fringe benefit label is life insurance carried to protect the financial well-being of a partnership or corporation should one partner or shareholder die. Similarly, so-called key-employee insurance can help a salon or other small business survive the death of a manager or key employee and thefinancial repercussions that oRen result. However, like fringe benefits, partnership or corporation life insurance are all subject to a number of restrictions imposed by our tax laws. WORKERS’ COMPENSATION

Common law requires every employer to provide a safe place to work, hire competent fellow employees, provide safe tools and

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equipment, and warn employees of any existing danger. An employer who fails toprovide any of these conditions is liable for damages if a worker is injured or killed on the job. Workers’ compensation insurance is needed to cover the risk. As a general rule, state law determinesthe level and type of benefits that are payable under workers’ compensation policies. Remember, however, that workers’ compensationis not required in some states when there are only one or two employees. Rates for workers’ compensation vary widely fromas low as one-tenth of 1percent of the payroll to as much as 25 percent of the payroll,depending onoccupations.Obviously,employees should be properly rated inorder toavoid overpaying premiums. Workers’ compensation insurance ratescan often bereduced by the simple expedient of keeping accident rates low. Even in a small salon, a good safety program can save money on workers’ compensation insurance premiums. Taking the time to think about allof the ways employees can (and have been) injured, putting it in writing, and educating all employees is frequently sufficient to qualify as a safety program. This alone will be enough, in most cases, to reduce the workers’ compensation insurance premiums.To reduce the claims or minimize the impact of those claims on the salon, however, requires every salon owner or manager to ensure that the safety program is followed. costs

Unfortunately, high medical costs, increasedlitigation, and higher incidences of fraud have combined to drive the cost of workers’ compensation insurance almost out of reach of most small businesses4espite the fact that payments are required under law. Originally, mandatory workers’ compensationinsurance laws existed in all fifty states. Today, three states-South Carolina, Texas, and New Jersey-have made workers’ compensationinsurance elective. But that election is only in the technical sense; employers are still liable for workplace injuries and could be in serious trouble if a major claimis filed in theabsence of insurance.

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For salon owners and operators in some states, workers’ compensation costs are not a problem. Most operators who do business in Oregon, forexample, have actually seen their costs decline over the past few years. Salons owners and employers in many other states around the country have not been so fortunate. Nationwide, workers’ compensation costs have tripled since 1980 and, according to many experts,could double again by the end of the 1990s. This problem affects every employer whether there aretwo or two hundred employees on the payroll. Compounding this is the fact that it is not a uniform crisis across the country. Some systems are working well, someare not. The abuses and the need for reform, however, have made headlines across the country. In California and Maine, state budgets were stalled over disputes about how to reform workers’ compensation systems. Reform measures were enacted in Colorado, Connecticut, Massachusetts, Texas, and Louisiana in 1991. So what can the average salon owner or any other employer doto fight spiraling workers’ compensation costs? One answer lies in better understanding the basic state laws governing it. Oregon’s workers’ compensation system is frequently used as a model of cost containment. Legislation turned the tide. By placing a cap on legal fees, requiring managed-care physicians, and reducing the number of claims one person can file, Oregon managed to reduce workers’ compensation rates by nearly 30 percent. Unfortunately, otherstates arenot doing as well. In Maine and Rhode Island, for instance, 90 percent of businesses have been forced into assigned-risk pools. Most cannot find affordable insurance because heavy losses have resulted in the majority of insurance carriers leaving the state. Maine, which had the second-lowestincome in the nation in 1991, ranked second in benefit payments for that same year. One insurance industry studyrevealed that national insurers paid out $1.23 for every workers’ compensation premium dollar paid in 1991. Alaskan salonsand other employers pay the highest rates in thecountry primarily as a result of exorbitant medical costs.

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When it comes to states with ailing workers’ compensation systems, California is often cited as among the very worst. According to the experts, the system is rotten with inflated medical bills and legal expensesas well as fraud. In California, costs are increasing but the number of claims are not. Employers’ costs tripled between 1982 and 1991, going from $3.6 billion to $10.6 billion. But, surprisingly, the rate of disabling injuries remained stableat approximately thirty-four per one thousand workers. What’s worse, the number of workers covered during thatperiod did not increase, makingit even more difficult to justify risingcosts, not to mention payingfor them. litigation rate is Where is the moneygoing?California’s increasing, particularly in southern California where 55 percent of all workers’ compensation claims are litigated. In northern California only 29percent of all claims go into litigation. The number of claims being litigated doubled between 1981 and 1991. As a result, litigation costs increased from $2,436 per case in 1981 to $7,030 per case in 1990. In other words $1.5 billion of the $11billion put into the system by employers in 1990 went for legal costs. One reason often cited for increased litigation is the hostof new and hard-to-prove types of claims. In California, for example, payments for mental stress havegone up 765 percent since 1980. On the rise in all parts of the country are claims for repetitive motion injuries. Fraud isn’t a problemonly in California. According to a recent study, it accounts for as much as 30 percent of claims in New York. Workers’ compensation medical costs across the country grew 50 percent faster than overall health costs between 1970 and 1988. California’s rate grew 65 percent during the same period. Study after studyshows that doctors are ordering more tests, procedures, and office visits for workers’ compensation patients than for other patients. Since workers’ compensationpays doctors directly,unlike medical insurancewhere patients usually pay and are subsequently reimbursed, these patients have littleincentive to help keep medical costs down. These increased medical and legal costs haven’t resulted in huge losses for California workers’ compensation insurance carriers

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only because their rates are increasing just as fast as claim costs are. The big losers, obviously, are employers and employees. With doctors and lawyers getting bigger and bigger slicesof the workers’ compensation pie, employees actually receive only about one-third of the total amount put inby employers. Many salon owners, however, are not optimistic about reform of the system. For them, the answer has been to keep costs manageable. While continuing to press for reformof the system, many salon owners have taken an activist approach to reducing their own workers’ compensation costs. Managing Costs

TOillustrate how an activist approach can be effective,consider a few of the stepsbeing taken by other salons. Something as simple as scrutinizing all workers’ compensation claims closelycan substantially reduce the number of excessive or fraudulent claims. Review claims, challenge claims, and, above all, make certain that the salon operation is not overpaying claims. When hiring new employees, a salon owner can legitimately attempt to find out whetherthe individual is physically capable of performing the tasks required for the job. Naturally, for those workers who are disabled, employers should tailor the workplace and tasks to meet the workers’ capabilities-that’s the law under the Americans with Disabilities Act (ADA). A salon can also implement safety programs to prevent illness and injury. Programs that include education and trainingon workplace hazards andsafe work procedures heighten awareness and show workers that the employer cares about them. Sponsoring wellness, stress management, substance abuse, and even defensive driving classes is yet another approach. Some middlesized salons/employers even holdsafety contests to reward safety initiatives by employees. How to Handle a Claim

If there isa claim, the manner in which the salon owner or operator reacts toit often affects how it turnsout. Injuredemployees

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who are uncertain about their rights often turn to experts (i.e., attorneys) for reassurance. Once that happens, litigationwill, in all likelihood, follow. Employers can reduce injured workers’ anxieties by informing them,early on, that all medical and hospital bills will be paid, work replacement payments will be forthcoming, and that thejob willbe waiting when the employeecan return to work.Most experts advise focusing the employees’ attention on recovery and reemployment, not disability. Getting an injured employee back to work quickly also cuts down on costs and the employee’s anxieties. In fact, by varying tools and changing job descriptions, employers can get many injured employees back to work early, therebyreducing costs. Safety Groups

Finally, it bears repeating, the one cost-saving step that should be taken by every salon requires every salon owner/employer to make a close analysis of all accidents and workplace illnesses, no matter how minor, and to take steps to correct all identified hazards. Many salon owners are forming insurance groups specifically to lower workers’ compensation costs. Most of these groups actually promote workplace safety as well as control costs. Safety groups enable small salon operations to share the expenses of providing safety, engineering, and a safety education staff. Although each group’s plan differs slightly, they all work on the premise that there is safety in numbers. Merely being in a safety group can often reduce initial workers’ compensation premiums. The low claim rates of salon operations that take an activist role or that belong to safety groups can mean continuing savings of up to 35 percent. Of course, these savings are usually offset by a small amount that goes to the group manager for administrative costs. GOING WITHOUT

In thisage of skyrocketing costs, it is alltoo easy to do without a lot of things. Insurance coverage, although quite expensive, is

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yet another areawhere something doesn’t cost,it pays. Imagine what justone lawsuit going against thesalon or its owner could do to the financial health of the salon operation. Even more frightening, every day the newspapers report on what to most of us appear to be frivolouslawsuits-lawsuits that are all too often won by the plaintiffs who, in turn, areawarded staggering amounts of money. Naturally, many of those settlements fail to standup on appeal. Butconsider the legal expenses of defending the salon against people who think they have been wronged. Consider the settlements thatmight have to be paid if the salon, its employees, and its owners are found to be liable. In addition to protecting against the consequences of these lawsuits, damage suits, and even workers’ compensation claims, the insurance company offers one service that no salon should be without. A protector with deep pockets. That’s right, the insurance company will not only compensate the salon for any losses (providing the salon is insured for that particular type of loss), but will also usually undertake the legal defense of the salon. Insurance is available to help make whole any salon that suffers any one of a large number of losses. But, as with every business decision, obtaining affordable and reliable insurance coverage requires investigation by the salon owner or manager. It also requires that some thought be given to the consequences of not having insurance.

CHAPTER SIX

Paying for Compliance

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The DeficitReduction and BudgetReconciliationBill of 1993 added greatly to the tax rulesand regulations every salon owner and operator must comply with in the course of doing business. Unfortunately, rather than provide financial relief or tax breaks for those salon operations that attempt to comply with these new rules or the increasing demands made on salons in the name of environmental protectionand employee health, welfare, and safety, our tax law onlymakes it more difficultto pay forthat compliance. Although our federal income tax law does provide at least partial relief from some of the financial burden of complying with the many rules created by federal, state, and even local governments, the new tax rules eliminated at least one deduction that was formerly available for the expenses incurred in fighting government regulations before and after their passage. The former deduction for lobbyingexpenses has been eliminated. Salon owners or operators may be faced with the need to make substantialexpenditures relating to the health andsafety of their employees. However, even though those expenditures may be required under law, they may not be immediately tax deductible, especially if they can be labeled as a capitalexpenditure. IS IT TAX DEDUCTIBLE?

Whether or not a particularexpenditure for health or safety is currently deductible largely depends upon the natureof the expenditure. If it is a repair,it is, of course, currently deductible; if it is a capital expenditure, it must generally be recoveredthrough depreciation. Under our extremely complex tax laws, it isdifficult to state a general principle or principles bywhich current business expenses can be distinguished from capital expenditures. Normally, a capital expenditure is one that results in the creation or acquisition of a new asset with a life of more than one year, an increase in thevalue of an existing asset or a prolongation of its useful life, or the fittingof an existing asset to a different use.

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If the second item is taken literally, it could be argued that the fitting of a safety device to a machine rarely increases its value or prolongs its useful life. Indeed, the result isoften a loss of operating efficiency. However, in one case that involved safety devices on elevators, the U S . Tax Court stated, “[Ilt is not necessary that the monetary value be increased or that thelife of the asset is prolonged . . . , a betterment of operating conditions, whether voluntary or involuntary, is a sufficient reason for capitalization.” In other words, the attitude of the courts appears tobe that the fact that the expenditure relates to another asset and does not increase its value or its life is irrelevant. It is not made for that purpose but to protect workers, customers, or the public from injury. The expenditure results in an asset (the safety device itself) with auseful life of more than one year and therefore must be capitalized. Those incidental repairs mandated by government laws, rules, and regulations that neither materially add to the value of the property nor appreciably prolongits life but, rather,keep it in an ordinarily efficient operating condition may be tax deductible provided, of course, that thecost of acquisition or production or its basis or book value is not increased as a result. In one instance, the repairs necessary to bring one salon owner’s buildinginto compliance with a city building code were labeled as capital expenditures even though the repairs didnot actually prolong the building‘s life. The reason? That compliance increased the value of the property. Regardless of whether an expenditure was made in order to comply with a governmental order such as changing the material used to charge air conditioning units, replacing shop equipment because of potential safety hazards, or even at thesalon owner’s insistence, the characterization of each expense as capital or current depends upon the circumstances surrounding its occurrence. One general ruleof thumb in this area is that item an with a useful life in excess of one year should be treated as a capital expenditure and not as a currently deductible repair expense.

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SPECIAL ASSESSMENTS

Further confusing the issue, special assessments andlevies tending to increase the value of the property, such as paving, sewer, sidewalk, or drainage, are generally not deductible but are capital expenditures that must be added to thecost of the land.They are not recoverable through depreciation and are not tax deductible even though the value of the property was not in fact increased. Special assessments levied against commercial properties in one town’s central business district that were to be used to provide for parking facilities on the edges of that district could not, at least according to our courts,be deducted as business expenses. In fact, they could not be deducted even when an appreciable business benefit was expected. On the other hand, the assessments levied by a city against business property owners for their share of the expense of converting a downtown city street into an enclosed pedestrian mall were ruled to be capital expenditures subject to depreciation over the period in which the mall was expected to provide a business advantage. Fortunately,the portion of payments made to meet interestcharges on city bonds issued tofinance the project arealso deductible. HELPING THE HANDICAPPED PATRONIZE THE SALON

A salon is, fortunately, permitted deduct to the cost of removing certain existing architectural and transportation barriers in the year when paid or incurred instead of capitalizing these costs and depreciating or recovering them over the life of the asset. The costs that qualify in this area arethose paid or incurred in order to make any facilitymore accessible to, and usable by, the handicapped and the elderly. Into this category would fall the costs of constructing a ramp toremove the barrierposed for wheelchair users by steps. Of course, the maximum deduction each year is limited to $35,000.

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First-Year Deductions

Code Section 179 was vastly improved by the tax law changes passed in 1993. The unique first-year write-off under Section 179 of our tax law permits up $17,500 to of the cost of qualified property to be deducted as an expense rather than as a capital expenditure retroactive to January 1, 1993. The principal limitation restricts theexpensing election to salonsthat acquire less than $210,000 in assets during thecourse of any one tax year. Compliance with government regulations can meanlarge expenditures of cash for capital improvements, a portion of which may be currently deductible as “barrier removal for the handicapped’’ or “Code Section 179” expenses. Repairs, of course, are immediately deductible as are those routine costs incurred in meeting the increased reporting requirements for everything from OSHA to the IRS. AMERICANS WITH DISABILITIES ACT

Although it was passed in mid-1990, the effects of the Americans with Disabilities Act (ADA) are just now beginning to be felt. As most salon owners and operators are already aware,the ADA forbids employers to discriminate against disabled people and requires every salon to provide an environment in which disabled employees can do their jobs. One of the questions still remaining to beanswered even after all of this time is the all-important one of just how the salon can afford to comply with this law or any other government mandate. The ADA became effective for those salons withtwenty-five or more employees onJuly 26,1992. Those salons with fifteento twenty-four employees were required to be in compliance by July 26, 1994. This means, according to our lawmakers, providing a barrier-free path to thework site, rearranging furniture, or modifying workstations and equipment. Only those salons/ employers who can prove that providing accommodation would cause undue hardshipare exempt. How much will compliancewith theADA actually cost? Even today, no one is yet certainwho willultimately be responsible for

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administering this law, let alone how strict that enforcement will be.However,according to the Job Accommodations Network (JAN), part of the President’s Committee on Employment of People with Disabilities, the cost of hiring a disabled person is almost the sameas hiring a person without a disability. One-third of those responding to a JAN survey of firms employing disabled peoplesaid that no expenditures were needed for physical accommodations. Half reported spending less than $50 in physical accommodations foreach disabled employee. 0thers, however, spent more than $1,000. The Disabled Access Credit

As already mentioned, under ourincome tax rules, most improve ments to any business operation’s premises, even safety improve ments to equipment, fall within the category of capital expenditures. In otherwords, their cost is usually only deductible over a number of years. One loophole to this general rule is something called the “disabled accesscredit.” The so-called disabled access credit is a unique tax credit for any eligible small business that pays orincurs expenses to provide access to persons with disabilities. Naturally, these expenses must be paid or incurred specificallyto enable the salon business or operation to comply with the Americans with Disabilities Actof 1990. This unique tax credit is equal to50 percent of the expenses over $250 incurred or paid to provide access to the business premises by disabled people. The ceiling is $10,250 per tax year. In other words, the maximum tax credit-a direct reduction of taxes rather than a tax deduction that only reduces taxable income-is $5,000. Only those amounts that exceed this credit can be deducted as expenses for the removal of barriers, capitalized and depreciated, or used to compute other tax benefits or credits. Fortunately, or unfortunately depending upon the size of the salon operation, under theregulations an eligible small business is defined as one that has thirty or fewer full-time employees or has $1 million or less in gross receipts for the preceding year.

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When it comes to qualifying, a full-time employee is considered anyone who is employed a t least thirty hours per week fortwenty or more calendar weeks. Expenses to provide accessto persons with disabilities include such thingsas: Removing architectural, communication, physical, or transportation barriers Providing qualifiedinterpreters to persons with hearing impairments and readers, tapes, and the like to persons with visual impairments Buying or modifying equipment for persons with disabilities Providing other similar services, modifications, material, or equipment

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The amounts spenton providing access forthe disabled that exceed the credit ceiling or don’t qualify for tax credit because the salon operation is too large may, of course, qualifjr for yet another option offered by our tax rules. Any salon is permitted to deduct the costs of removing certain existing architectural or transportation barriers in the year paid or incurred instead of capitalizingthose costs anddepreciating or recovering them over the life of the asset. Thespecific costs that qualify for this tax deduction are those paid or incurred in order to make any facility owned or leased by the salon operation more accessible to, and usable by, the handicapped and the elderly. This encompasses such things as the costs of constructing aramp for wheelchair users. Naturally, even this one-time option has its limits under our tax rules. The maximum deduction for expenses paid or incurredeachyearwas originallylimitedto $35,000, a n amount that has since been reduced to $15,000 per tax year. What’s worse, the barrierremoval must meet the standards set by the Architectural and Transportation Barriers Compliance Board. Every improvement is assigned a useful life and it is over that period the cost is writtenoff, depreciated, or recovered.

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CAPITAL IMPROVEMENTS

The cost of modifying or reconditioning property, either abuilding or equipment, is a capital expenditure because there is usually a resulting increase in value, an extension of the useful life of the property, or improvement to or in the usability of the propertyall factors that tend to indicate a capital expenditure. General reconditioning of property, either upon acquisition to makeit suitable for the salon’s purposes, or as required to comply with current laws or regulations, is treated as a capital expenditure as well. This is the case even though individual parts of the job might otherwise be treated asimmediately deductible repairs. The bottom line is,however, that developing an environment suitable for disabled workers or customers with handicaps isn’t as difficult as it might at first appear. Their ergonomic requirements are not that different from the average office worker according to many office furniture experts. Adjustability seems to be the key to ensuring thatoffice furnishings or salon fixtures can fit any user’s needs, disabled or not. Just as a work environmentshould be able to accommodate a very tall or very short worker, it should be flexible enough to accommodate a worker with limited mobility or another type of disability. Education One of the big problems under this law is that of educating employees so they do not shy away, as many people do when encountering a disabled person. That education is critical. A salon could spend a great dealof money removing architectural barriers, butif there is just one employee who won’tlet someone with aguide dog comein, thesalon could be slapped with a lawsuit. Employee education is generally deductible by an employer. And, since this type of education is for the employer’s benefit as well as toimprove existing employee skills, the employee is enti-

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tled toa full tax deduction for any educational expenses paid for or reimbursedby the salon. Legal Expenses

Under our existing tax rules, a deduction for legal and related expenses incurred in defending a salon business against charges of illegal acts or practicesis generally allowed,whether or notthat defense is successful. For example, amounts paid in settlement of a civil judgment that was based on illegal activities, including fraud, were tax deductible in onecase.Similarly, charges for audits, record-keeping services, procedure reviews, cost surveys, and similar services performed at intervals of one year or less are deductible as current expenses. Compliance, in other words, is usually tax deductible as either a current expense or as a depreciable expense. Never deductible, however, are bribes, kickbacks, or other illegal payments regardless of howtempting that solution might be. Quite simply, a bribe or illegal kickback paidto a public official or government employee cannot be deducted.Fines and penalties paid to the government for the violation of any law are also never tax deductible as business expenses. On the other hand, fines that are not by nature penalties are usually tax deductible. The IRS and thecourts have, for example, allowedtax deductions for National Labor Relations Board awards for liquidated damagesunder the Fair Labor Standards Act and penalties under the Federal Water Pollution Control Act for oilspills. Liquidated damages paid under the Walsh-Healy Act are deductible if made on accountof minimum wage and overtime violationsbut not for childlabor violations. There apparentlyis some confusionabout just which agency is going to be responsible for administering the Americans with Disabilities Act. Regardless of whether federal, state, or even local governments are ultimately responsible for administering, inspecting, and fining those who fail to comply, there will be those salon ownersand operators who feel that a fine or penalty will be cheaper than compliance.

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WHAT IS BEST FOR T H E SALON?

One strange fact about our income tax law, however, is that it takes littlenotice of what is in thebest interestof businesses. In this case, the mere factthat it is to the salon’s pecuniary advantage to pay a penalty rather than to comply with the law does not convert a penalty into atax deductible business expense. Fines and penalties paid to a government for the violation of any law are not tax deductible as business expenses. Legal expenses for defending against a penalty may, however, be deductible,at least insome circumstances. Should a disabled person or a government entity sue the salon and win, the resulting judgment will not be tax deductible unless the award includes a forced compliance provision.In that case, only where the expense for complying would bea business expense is a tax deduction permitted, but, once again, never a fine, penalty, or interest under that judgment. But what about serious compliance? Engaging an attorney or any professional whoseservices are needed to explain, implement, or fight any government mandate is usually a tax deductible expense so long as it is business oriented. However,if the legal expense corresponds to an asset acquisition or other capital expenditure, then these feestoo, must normally be capitalized and depreciated over the life of the underlying asset. Easing the Financial Burden of Complying

It mayrequirealittleresearch,but income tax credits and deductions do exist to help ease the financial burden of complying with ADA and the alphabet of other rules and regulations that face salon owners and operators every day. The actual outof-pocket expenditures for complianceshould not, if our lawmakers are to be believed, be excessive. Even the legal, accounting, and other professional fees incurred to understand and comply are taxdeductible. But left unsaid is theincreased profits necessary to pay for that tax deductible, mandated health and safety equipment or related reporting.

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Profiting from Compliance

Every salon owner and manager is aware, or should be aware, that there isa cost for not complying with all thesegovernment rules and regulations. Those who have been through the mill are also aware that thecost of complying includes not only a dollar cost but also the hidden cost of time spentkeeping abreast of the rules, new and existing, and the time involved in actually complying. But whatabout the bottom line? Public transportation has long been required to be accessible to the handicapped. In fact, local municipalities spend millions of dollars each year for buses with special elevators to help the disabled board the bus. Most of those expensive elevators, however, remain unused on most buses. Similarly, a salon owner or manager may view the expense of making the salon accessible to someone in a wheelchair as prohibitively expensive, particularly if none of the salon’s customers use wheelchairs. The law, however, has established rules that all salons above a certainsize must be wheelchair accessible. For the expense of modifylng the salon to comply, the salon receives a tax credit, an immediate tax deduction of some of the expenses, and a depreciation deduction for the bulk of the expense. The salon also avoids litigation, nuisance suits by local activist groups, and possible fines and penalties. On the upside, the salon is now able to hire disabled or handicapped workers, can offer their products and services to handicapped or disabled customers, and can expand their business to a whole new audience, a group that may never have thought of utilizing that salon because of its inaccessibility. And don’t forget those who are not handicapped. Millions of people who are merely old, temporarily incapacitated, or injured will find it far easier toaccess the salon in compliance with these rules granting access to the disabled. The customer injured in a car accident and temporarily on crutches will not seek out another salon or forego a visit until healed if the salon is accessible. Although few salon owners or managers will bother to look into the unique tax credit for hiring additional workers from

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groups targeted by our lawmakers as deserving special attention by employers, they will still benefit from an additional pool of extremely qualified workers that may be disabled or handicapped. Even without the unique Targeted Jobs Tax Credit, a tax credit equal to portion a of the first-year wages paid new employees from these groups, many salon owners have found their most productive and willing workers from among the handicapped and disabled, groups of employees who couldn’t be accommodatr ed prior to the passage of the American with Disabilities Act.

CHAPTER SEVEN

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One of the most controversial areas of our tax rules is that which defines who is and who isn’t an employee when it comes to income tax purposes. As most salon owners are already aware, for every stylist attempting to label him- or herself as an independent contractor, there are two frightened employers labeling them as employees. Who is right in the eyes of the IRS? Which path is rightfor you when additional help is needed? EMPLOYEE/EMPLOYER

According to the IRS, physicians, dentists, veterinarians, contractors, and others who follow an independent trade in which they offer services to thepublic are not employees. However,such professionals can be considered employees if they are hired by another professional who has the right to assign and supervise their work and who pays them a salary. In general, that means it is possible for stylists, hairdressers, or beauticians to be independent contractors for incometax purposes. They may also be considered as employees in other situations. Thus,the present almost constant battlewith IRS auditors all anxious to ensure thepayment of proper taxes. Only employeesare subject to withholding of income and payroll taxes. Self-employed stylists, beauticians, and hairdressers, on the other hand, are usually liable for the payment of selfemployment taxes. Employees may deduct only certain jobrelated expenses and even then are subject to limitations and restrictions as to the amount that may be claimed as taxdeductions. Self-employed stylists or hairdressers are entitled to far more leeway in deducting the expenses of conducting their profession. And then there are also the mattersof status, other tax benefits, and sheltering income, all of which enter into the argument over who is and who isn’t an employee. The individual prefers the financial freedom, tax advantages, and, all too often, the ease withwhich many self-employed individuals avoid their tax liabilities.

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Under our tax rules, no distinction is made between classes or grades of employees forwithholding tax purposes. An individual is either an employee or not an employee. Superintendents, managers, and other supervisory personnel usually are employees. Also, officers of a corporation are generally employees even though they receive payment for services in the form of “draws” rather thansalary. Corporation directors in theircapacity as such or even officers who perform only nominal duties or receive only nominal remuneration are generally not employees for tax purposes. Similarly, bona fide members of a partnership are not normally considered employees. Thus, withholding does not apply to their advance “draws” or “salaries.” To avoid the restrictions and the statusof being an employee, many stylists, hairdressers,beauticians, and otherbeauty-related professionals have gone to great lengths. One incorporated salon, for example, was required by the courts to withhold income and employment taxes on the amounts paid to stylists who performed services for that salon. Apparently, the stylists and hairdressers had assigned their lifetime services to a trust. The corporation then signed service contracts withthe trusts, rather than the individuals, agreeing to pay the trust for the services the individuals rendered. Despite all of this work, the individuals were employees in theeyes of the courts and withholding by the salon for wage taxes was required. Obviously, having an independent contractor perform services for the salon is far easier for the salon owner or manager than filling out the manyforms, withholding requirements, and payroll taxes necessary foreven the lowest-paid employee. Thus, the legal definition of an “employee” becomes important. Under our tax rules, an “employee” is considered to be an individual who performs servicessubject to control by an employer both as to whatservices shall be performedand asto how they shall be performed. It does not matter that theemployer permits the employee considerable freedom of discretion and action so long as the employer has the legal right to control both the method and the resultof the services.

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Primer

In fact, it is not even necessary that a person actually direct or control the manner in which services are performed in order for that person to be considered an employer under the taxrules. It is sufficient that theemployer has the rightto do so. In addition to the right to control both what will be done and how it will be done, there areother common characteristics of an employer-employee relationship. One of those characteristics is that anemployer has the rightto discharge an employee. Another characteristic is that anemployer usually supplies the employee with a place to work and the necessary tools for the job. This is not always the case, particularly where salons expect their stylists and other professionals to provide their own tools and equipment. FICA EMPLOYEES

Establishing that a worker is, in fact, an employee,does not always end the question of an employer’s liability for payroll taxes. In order for any employer to be obligated to withhold a n d or pay these taxes, the employee must be engaged in so-called covered employment. And then there is the definition of a “FICA” employee. In general, there are three classes of coverage under the Federal Insurance Contributions Act (FICA):

1. Officers of corporations, provided they do more than a nominal amountof work 2. Employees who qualify as such under thecommon law rules 3. Workers who fall within one of four occupationalgroups even though they do not qualify as employees under the other two guidelines-agent drivers or commission drivers such as bread and beverage delivery people, full-timeinsurance salespeople, home workers, and salespeople Once it has been determined that a worker is, in fact, an employee, it is immaterial what name the parties themselves may give to their relationship. Under our tax laws, there are employees and independent contractors.

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Social security taxesdo not have to be paid or withheld from any amountspaid to an independent contractor. However, ifthe independent contractor is paid more than $600 in a calendar year, thepayor must reportthose payments to the IRS (on Form 1099-MICS, Statement for Recipients of Miscellaneous Income). RELIEF PROVISIONS

Congress has provided relief provisionsto protect employers from penalties from misclassifylng employeesas independent contractors. However, in order to be eligible forthis relief, the employer must file all required federal income tax returns on a basis consistent with the classification of the worker, must not have treated any worker in a similarposition as anemployee, and must have a reasonable basis for the classification of the worker. Unfortunately, this relief provision does not apply to any worker who providesservices for a client as a technical specialist (such as anengineer, drafter, computer programmer, or systems analyst) under an arrangement between a business and thebusiness operation’s customer or client. In other words, third party situations arespecifically excluded fromthis relief provision. Thus, where a salodemployer directly contracts with a professionalortechnicalservicespecialist to provideservices to the salon’s customers, the relief provisions maystill be used. However, a firm that supplies temporary or part-time workers to the salon or beauty business must consider those individuals to be employees and treat them accordingly for withholdingtax purposes. Naturally, this exclusion does not automatically convert all technical service specialists into employees for employment tax purposes. It merely requires that theclassification of such workers as eitheremployees or independent contractors be governed by the common law standards. DEFINITIONS

Congress frequently threatens to pass legislation that will define “employee” and “independent contractor” once and for all. How-

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ever, until such time asCongress enacts that legislation governing the classification of workers as independent contractors or employees, a salon owneror operator can continue treating workers as independent contractors without incurring income tax withholding penalties. But, remember, present law says that thepresent classification employed by the salon to differentiate between employees and independent contractors can continue to be used only if there is a “reasonable basis” for not classifylng the individual as an employee, the salon did not or does not treat an individual as anemployee, and the salon files all tax returnsrequired (including information returns) on the basis that anindividual is not an employee. A salon that meets the reasonable basis test can exclude any individual or individuals from employee status, but only if the salon reasonably relies on oneof the following types of authority:

. . .

A so-called judicial precedent or a notice from the courts or the IRS A past IRS audit of the salon’s books in which the IRS did not assess employment tax deficiencies for amounts paid to individuals holding positions substantially similar to posia tion held by a particular individual A long-standing, recognized practice of a significant segment of the industry inwhich the individual was engaged

These three tests arenot the exclusive means of satisfylng the reasonable basis requirement as even the IRS admits. A salon owner or operator may also satisfy the reasonable basis requirement by general evidence that the individual functioned as anindependent contractor rather than as an employee. Making It Legal Finally, if there is any doubt as to whether a worker is an employee for purposes of income tax and FICA withholding, either the salon or the individual can request that the IRS

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determine whether theworker is an independentcontractor or an employee. This is accomplished by submitting Form SS-8 to the IRS. The other partyaffected by the requirement may also have to submita Form SS-8. After receiving Form SS-8, the IRS conducts an investigation of the matter by obtaining information from both the individual and thesalon. The IRS official conducting the investigationwill attempt to resolve any differences in theinformation provided. After the investigation is concluded, the IRS will issue a written rulingon the statusof the individual. Subject to appeal at a higher level of the IRS or even taking the matter tocourt, the question of whether any individual is an independent contractor or an employee should be resolved. Employees who wish to be labeled and treated as independent contractors, independent contractors who value their status and the tax“perks,” and employers who prefer to deal with either employees or independent contractors should attempt to rely on the guidelines already provided. The many salon owners and operators who have never addressed this potentially sticky problem may go along for years blissfully unaware of the IRS’s crackdown on all those people who use independent contractor statusa as means of avoiding or ignoring taxes. Reality comes only when the IRS audits their income tax return. AUDITS

The Internal Revenue Service wants to understand the salon business. Throughan unusualprogram introducedlate in1993, the IRS now provides their auditors withguidelines designed to help them to better understand-and more effectively auditbusinesses inmore than eighty industrygroups. According to the IRS, the Market Segment Specialization Program (MSSP) represents a significant changein taxadministration that is certain toimpact mostindustries butespecially small businesses. The MSSP focuses on groups of taxpayers who

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have similar circumstances or business purposes. The IRS then develops audit guides to assist their auditors in understanding the business practices of organizations with similar characteristicsall salons,for instance. That means that if oneindustry has a tradition of placing more money in theowners’ pocketsthan in the cash drawer, the IW will Iabel all similar types of businesses for closer scrutiny. Similarly, practices unique to a given industry will be revealed to auditors across the country enabling them to better understand or look for similar practices as they audit local businesses. Although it was originallypromoted as a means of helping its auditors better understand how a salon or other small business works, in reality this new program is yet another way to increase the effectiveness of the growing numbers of IRS employees whoare being converted from vanishing clerical positions into auditors as theIRS modernizes, computerizes,and streamlines its operations. The reason for the increased numbers and effectiveness of audits is simple: more and more salon owners and operators are being forced into voluntary compliance with ourtax rules. After all, if voluntary compliance can be increased by only 1percent, revenues to the government will increase by a whopping $7.5 billion each year. The increased risk of an audit, and an auditby an IRS employee who has a better understanding of the salon business, is already a reality. The best way avoid to an auditor to cope with it, however, remains the same as in the past. The answer is to understand how income tax returns areselected for review and how the taxsystem works. How the System Works

There are, for example, two major reasons why any salon’s income tax return would be examined. The first is pure chance. Each year the IRS routinely selects a number of tax returns at randomand subjects them to a thorough examination. The results are used to refine and adjust the computer “model” that the IRS uses to select other tax returnsfor checking.

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As soon as they are received, all income tax returns are immediately checked for accuracy. Then, using their computer model as a basis for a so-called average tax return, the IRS’s computers “flag” any unusual items-high income, large or unusual deductions, self-employed hairdressers, and especially unusual types of businesses. Depending upon how busy IRS auditors in a given region are, tax returns are selected on the basis of how many flagged items the return contains and selected for future review. It is at this point that the unsuspecting salon owneror operator’s own actions can reduce the possibility of amore extensive examination. If the tax returnselected on the basis of those flags wasaccompanied by documentation to support those flagged items or any other questionable areas, the tax return may be returned to the system with the examiner’s questions already answered.A few others will result ina form letter being generated to document or explain the questionable deductions or any discrepancies revealed by that computer comparison. The bulk of those flagged returns, however, are given further attention by an IRS auditor and a meeting is scheduled with the salon owner/taxpayer. That is where things begin to get scary. After all, it is here that theIRS is legally required to inform everyone about their rights under the law. Taxpayer Rights

Among the more important rights given to any salon owner or operator is whether they choose to be represented by a tax professional or prefer to attempt to answer the IRS’s questions alone. Fortunately, those whodo attempt to represent themselves or their salon operations have the further right to halt the auditproceedings a t any point in order to secure that representation. An important consideration for every salon owner and operator being audited is where the meeting should be held. Should it be in the accountant’s office where all of the working documents,innocent or potentiallyincriminating, are easily

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accessible? Should it be at the salon, the place where all the records are kept, to demonstrate to the IRS auditor there is nothing to hideand that thesalon operation is a legitimateone? Or, should the salon owner and/or his or her representative trudge down to the IRS office armed only with the specific documents and information requested by the IRS auditor? There is no one right answer. The experts are divided on whether it is better to have the IRS auditor come to the salon or to the salon’s accountant because with immediate access to the salon’srecords and other documents, the scope of a relatively basic audit could rapidly escalate. An IRS office audit allows the salon owner and/or his or her representative to control the documentation presented, but this process is time consuming with no guarantee that a suspicious auditor won’t expand the investigation. Because of the complexity of our basic tax laws, few IRS auditors cannot, if pressed, find some point to contest. Fortunately, however, results of an audit being unfavorable does not necessarily mean thatadditional taxes mustbe paid.

No Payment Required Until the salon owner or operator agrees with the IRS, the appeals process remains open. And fromthe initial screening for accuracy that each return receives upto the final appeal, mistakes in favor of the taxpayer are discovered in about 25 percent of all cases. So audit results are not always a foregone conclusion. The IRS is usually quite sympathetic to honest mistakes and more than willing to discuss underpayments of taxes that may result from the many so-called gray areas of our tax rules. They’ll even negotiate the amount of tax due on occasion. But they don’t like fraud. Fraud and Cheating

Generally, all income taxes must be assessed within three years afker the original return is filed. However, taxes may be assessed or a court proceeding to collect taxes commenced at any time if the

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return is fake or fraudulent, there is a willful attempt to evade tax, or no return is filed. In the case of a fraudulent tax return, theIRS may impose additional taxes at any time, without regard to the statute of limitations. Of course, the burden of proof in thesecases always falls on the government. Normally, under our tax system, it is the taxpayer who must prove innocence. If a salon owner or operator omits income in excess of 25 percent of the amount'reported as gross income, a six-year limitation period on assessment applies.An item will not be considered as omitted from gross income if information sufficient to apprise the IRS of the nature and amount of such item is disclosed on the return or in anyschedule or statement attached to the return. The majority of salon owners and operators, however, filerelatively honest returns, andonly occasional misinterpretations or honest disagreementsresult inadditional tax assessments at the audit level. Should the salon owner or operator question the additional assessment or any findings of the auditor, the first step of appeal is at the appellate level of the IRS. Appeal Without Payment

A disagreement over an auditor's findings is usually referred to the appellate level wherethe IRS's representative is more knowledgeable and empowered to be more lenient. Even here, however, the salon owner or operator does not have to agree with thefindings. Of course, while the additional taxes demandedby the auditor or his or her supervisor go unpaid, the interest and any penalties on those contested taxes continue to accrue. But further appeal is still possible without payment.

U.S. Tax Court The mainpurpose of the U.S. Tax Courtis to review deficiencies asserted by the IRS for additional income, estate, giR, or self-

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employment taxes. The Tax Court is the only judicial body from which relief may be obtained without the payment of tax. In general, salon owners or operators have the burden of proof when they go to the US.Tax Court. However, they must only establish that the IRS is in error andnot whether any tax is actually owed. Once again, of course, the burden of proving fraud is on the IRS. The Tax Court maintains relatively informal procedures for the filing and handling of cases where neither the taxdeficiency in dispute nor the amount of claimed overpayment exceeds$10,000. Usually, salon ownersor operators represent themselves, although they may be represented by anyone authorized to practice before the IRS. Unfortunately, decisions by the small tax case division of the U S . Tax Court cannot set a precedent that can be used by others in similar circumstances nor can the decision beappealed by either thesalon owner or the IRS.

Back to Court-After

Payment

Naturally, salon owners or operators who losein regulartax court may appealthe case to a proper U.S. Court of Appeals merely by filing a notice of appeal with the clerk of the U S . Tax Court. But the free ride ends with the Tax Court’s ruling. If the Tax Court decides in the IRS’s favor, future appeal requires the posting of an appeal bond guaranteeing payment of any tax deficiency that may be finally determined. As illustrated, that basic audit of a salon’sincome tax return need not be the end of the world. If that examination does result in an assessment of additional taxes, appeal after appeal is possible until at some stage compromise is reached or the salon owner is satisfied. The independent contractor controversy has resulted in a higher than usual numberof tax audits. With the IRS increasing theirknowledge of the business practices industry by industry, those audits have an increased impact on the pocketbooks of every salon owner and operator. Plus, there is one more area of

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controversy where the tough rules are stacked in favor of the IRS-home-based salons. HOME-BASED SALONS

Our tax rules are quite clear: taxpayers are not entitled todeduct any expense of using their homes for business purposes unless they are attributable to portion a of the home (or separate structure) used exclusively ona regular basis as:

=

The principal place of any business carried on by the taxpayer A place of business that is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of business or in connection with the taxpayer’s business if the taxpayeris using a separate structure that is appurtenant to, but not attached to, the home

Under these tax rules, a specific portion of the taxpayer’s home must be used solely for the purpose of carrying on a tradeor business in order to satisfy the exclusive use test. Such requirements arenot met if the portion is used forboth business and personal purposes. Furthermore, an individual is denied a business deduction for basic local telephone service charges on the first line in the business. Additional charges for long-distance calls, equipment, optional services (i.e., call waiting), or additional telephone lines may be deductible as home-office-related business expenses. Further Home-Office Limitations

If the in-home salon does qualify for the home-office expense deduction, that deduction will be limited to the gross income that is earned from that in-house activity. An individual who is anemployee of a salon may, on occasion, claim a tax deduction for home “office” or home “salon”expenses.

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However, in order for an employee to qualify for this deduction, he or she mustmeet the requirements already established for the business use of the home. Plus, the exclusive use of the home salon or office must be for the convenience of the employer. Naturally, any expenses claimed by an employee must be taken asmiscellaneous itemized deductions subject to the 2 percent floor.

CHAPTER EIGHT

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Salon owners or operatorsenjoy a numberof benefits from owning their own business. From the tax and financial viewpoint, business ownership carries withit access to a number of fringe benefits. Naturally, most of the fringe benefits desired by the salon’s owner must also be available to the majority of employees, but the salon owner dictates which benefits will be offered. (Refer to Appendix A for a complete Tax Deduction Checklist.) Exempt from the nondiscrimination requirements already outlined (in the section on fringe benefits) is the business ownership benefit of nepotism. That’s right, there is no rule that prevents any salon owner or operator from employing a spouse, children, or other family members in the business. There may even be tax advantagesassociated with that nepotism. With our complex and often confusing tax rules, thereis no one “right” way to own the salon operation. The choices range from sole proprietorships to partnerships to two choices of corporations, regular and the small business or S corporation that is treated much in the same manner as a partnership for tax purposes. Further clouding this question, the subject of spouses and family members mustbe considered. SPOUSES AND FAMILY MEMBERS

One salon owner may be concernedwith estate taxessomewhere down the road and decide that anincorporated salon will reduce that eventual estate taxbite. Another salon owner and his or her spouse will be concerned with acquiring the required number of Social Security “quarters” for a spouse employed in the salon operation. Still anothersalon owner may wantto attempt to split the salon’s income among family members in order to reduce the total tax bite. Mere ownership or joint ownership of business property does not automatically qualify any spouse for self-employment tax purposes. Accordingly, if a salon owner and spouse are personally operating a salon or other property that they hold as joint tenants, the net profits are, generally, all treated as one partner’s net earnings from self-employment.

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Most salon owners operating as sole proprietorships are familiar withthe general rule that services performedby an individual in theemploy of his or her spouse are not considered “employment” for Social Security (FICA) or unemployment (FUTA) tax purposes. Consequently, the self-employed salon operator who hires his or her spouse need not pay or withhold Social Security taxes on spousal wages. Tax Benefits

If proof is required that the hiring of a wife or husband is a smart move for income tax purposes, one quick look at the tax withholding rates should be enough to convince anyone. After all, the 1994 Social Security tax rate was 7.65 percent each for the employee and theemployer (a totalof 15.3 percent). Ordinarily, any individual who owns a salon may create a “working family” by employinghis or her spouse and paying the spouse a salary. Employing one’s spouse can be an extremely attractive method for splitting the family’sincome in such a manner as to take full advantage of our tax system. If handled properly, the employer gets a tax deduction for compensation paid while the spouse receives taxable cash income and, insome cases, other economic benefits such as insurance coverage or pension plans with no or minimal tax price to the salon. Obviously, the employer cannot take a legitimatetax deduction if the spouse does not actually perform services for the salon operation or if the services rendered bear no reasonable relationship to the compensation paid. If the compensation paid is to be deductible in full by the employer, it must be reasonable. To be considered “reasonable,” the compensation paid to the spouse must be in accord with the prevailing rate of compensation for comparable positions with comparable employers. In the event that the compensation paid is determined by the IRS to be excessive, the employer’s deduction will be lost to the extent that the amounts paid exceed reasonable compensation. Another tax consequence of spreading the salon’sincome between a husband andwife is to reduce the self-employment tax

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the owner must pay on his or her own self-employment income. Such income dividing is subject to the reasonable compensation rules, but, assuming theoperation’s burden of proof can be met, the reduction of combined family employmenttax liability is substantial. Remember, however,the employee-spouse whois not covered under the Social Security Act will not be earning credits for the normal Social Security benefits as do other compensated employees. In addition, the self-employed spouse with reduced earnings will be compiling proportionately fewer Social Security retirement benefits for him- or herself unless earning enough to pay the maximum in Social Security taxes for the year($60,600 maximum earnings basefor 1994). PARTNERS

Where the spouse is a partner in the partnership, the partnership is not required to withhold income tax from distributions made to that partner. However, that partner may be subject to self-employment tax on any distributions. Of course, under our tax rules, a partnership does not exist wherea spouse whoassists in a business does not participate in, or have a right to participate in, the management of the business, even where profits from the salon are treated as family funds. As a general rule, a person workingas an employee fora pax% nership in which his or her spouse is a partner is considered to be an employee of the partnership, not of the spouse. Thus, Social Security taxes must generally be paid onthe employee’s wages. However, an exception exists if each memberof the partnership is related to the spouse-employee in a manner that would allow that partner toavoid withholding on the employee’s wages if the partner were self-employed. In other words, a person employed by a salon partnership that consisted solely of his or her spouse and children (e.g., a mother-daughter partnership that employed thehusbandfather) is notrequiredtohave income tax withheld from his or her wages.

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Even though there is no income tax advantage in forming a husband-wife partnership in order to shift income from one spouse to another, such a partnership may be desirable for another reason. A husband-wife partnership entitles the nonworking spouse to Social Security retirement benefits due to the self-employment tax on partnership income. The IRS has agreed that such partnerships are valid forthis purpose. Although shareholders of a so-called S corporation are treated much in the same manner as partners, they arenot subject to the self-employment tax on their share of the S corporation’s ordinary income attributable to the operation of the salon. Similarly, whenit comes to determining the applicability of Social Security tax to employment, a person working for a regular corporation in which his or her spouse owns stock is considered to be an employee of the corporation, not of the spouse. After all, a corporation is a separate entity for tax purposes. In fact, this is true even where thespouse is the sole shareholder of the corporation. Although the question of qualifying for Social Security benefits at some future date is one of the long-range factors that must be considered, even further down the lineis the estate tax question. ESTATE TAXES

It is a popular misconception that joint tenancy with survivorship rights is always the best form of asset ownership between spouses. Although joint tenancies between spouses do have many advantages, theyalso may result inadditional estate taxliability. In thecase of property jointlyowned with right of survivorship by spouses, the estate of the first spouse to die includes one-half of the value of the property regardlessof which spouse furnished the consideration for the property. Although this rule may facilitate qualification for special tax law provisions, the unlimited maritaldeduction may makeit inadvisable for estate owners to place individually owned property into jointtenancy.

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The provision for the unlimited marital deduction makes it possible for an estate owner to hold assets individually until death and then transfer property the by willto his or her spouse without estate tax liability. By doing so, the surviving spouse receives a stepped-up income tax basis or increased book value for the property. If the estateowner transferred the property into joint tenancy, the spouse would receive a stepped-up basis only for the onehalf interest acquired from the decedent at his or her death. The spouse would have a basis carried over from the estate owner in the one-half interest transferred to her or him duringtheir lifetime. The ease andspeed of transfer of joint tenancy property to the surviving spouse is another major advantage to spouses holding property in joint tenancy. Becausetitle tojointly heldproperty automatically passes tothe surviving joint tenant on the death of the first tenant, court action is not required. Thus, the survivor will not have to relinquishcontrol of the property to the decedent’s estate but can maintain continued use of the property. On the other hand,property held jointlyby married couples has several disadvantages. First, inclusion of one-half of the value of the property in thegross estate of the first spouse to die will mean that the surviving spouse will receive a stepped-up income tax basis only with respectto one-half of the value of the property. Second, the estate owner cannot control, in any way, the disposition of the property after death (since the survivor automatically takes titleindividually at death). Regardless of what the future mayhold in theway of new tax rates or rules, owning and operating the salon jointlyas husband and wife requires a number of decisions that should be made now to reap all of the many benefits. ENJOYING SALON OWNERSHIP

Another benefit of salon ownership is the fact that Uncle Sam, in theform of our tax laws, is willing to pick up part of the tab

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for you having fun. That’s right, a salon owner or operator can entertain, travel, and attend trade shows and conventions with a financial helpinghand from our tax rules. Unfortunately, on January 1, 1994, running a salon became a lot less enjoyable. On that date, a number of the provisions of the Revenue Reconciliation Act of 1993 began to take effect. Beginning in 1994, there areno more income tax deductions for club dues, the few tax deductions that resulted when a salon owner or operator took a spouseor children along on a businessrelated trip became even fewer, and thoseroutinebusiness meals and entertainingbecame more expensive. That’s right, business meals lost even more of the amount that could beclaimed as a business expense on the annualincome tax return.The portion of meal and entertainmentexpenses that may be deducted as a trade or business expense has been reduced to 50 percent of the amount actually spent. Until December 31, 1993, 80 percent of those meal and entertainment expenses was tax deductible. The actual impact of this change is relatively minor to most salon owners and operators. But the restrictionson the portion of meal and entertainmentexpenses that can be deducted may result infewer owners and operatorseven attempting to qualify business-related meals or entertainment for a tax deduction. Thus, lesstax-deductible fun and perhaps less business. ENTERTAINMENT EXPENSES

As mostsalonowners

andoperators are alreadyaware, an entertainment-related mealexpense is not tax deductible unless the owner is ableto establish that theexpense is directly related to theactive conduct of a salon or other business. Of course, if a meal directly precedes or follows a substantial and bona fide business discussion (including a business meeting at a convention), then it is tax deductible if it is established that the expense was associated withthe salon or other business. There are two additional restrictions placed on the deduction of meal expenses.

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1. Meal expenses generally are not deductible if neither the salon owner nor the salon’s employeeare present at themeal. 2. A deduction will not be allowed for food and beverages to the extent thatsuch expense is lavish or extravagant under the circumstances.

Obviously, the salon owner or operator must substantiate the deduction. Then, in order to claim any deduction, the salon owner or operator must be able to prove that theexpense was, in fact, paid or incurred. The following expenses, which are deemed particularly susceptible to abuse,must be substantiated by either adequate records or sufficient evidence corroborating the salon owner or operator’s own statement: Expenses relating to travel away from home(including meals and lodging) Entertainment expenses Expenses relating to so-called listed property such as cars and computers In order to be tax deductible, the amount and the business relationship of the person being entertained must be substantiated. According to our lawmakers, a contemporaneous log is not actually required. However, some record of the elements of the expense or use of the listed property must be made at or near the time of the expenditure or use. When supported by sufficient documentary evidence, these records have a high degree of creditability with IRS auditors. Adequate accounting generally requires the submission of an account book, expense diary, log, or similar record maintained and recorded at or near the time of occurrence of the expense. Documentary evidence, in the form of receipts or paid bills, is generallyrequired for lodging and anyother expenses that exceed $25.

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Directly Related Test

In order for any entertainment expense to meet the directly related test imposed by the IRS, the salon owner or operator must have had more than a general expectation of deriving income, or some other specific business benefit, at some indefinite future time. In addition, the active conduct of business must be the principal aspect of any combined business and entertainment. Entertainment expenses associated with the active conduct of the salon business are deductible so long as they directly precede or follow a bona fide and substantial business discussion. These tax deductible expenses associated with operating the salon or beauty-related business include goodwill expenditures made to obtain new business or to encourage continuation of existing business relationships. Once again, the business discussion must be the principal aspect of the combined entertainment and must represent an active effort by the salon owner or operator to obtain income or other specific business benefits. And, in addition to that recently eliminated deduction for club dues, the salon owner or operator can also forget about attempting to claim any tax deductions relating to what the IRS labels entertainment facilities. Our lawmakers long ago ruled out tax deductions for entertainment facilities such as yachts, hunting lodges, swimming pools, tennis courts, or bowling alleys. Despite the recent curtailment of tax deductions for meals and entertainment, there remain a few other deductions for entertainment expenses, provided, of course, that they meetthe ordinary and necessary requirements and are properly substantiated:

. . .

Food and beverages for employees furnished on the business premises or job site. Expenses for services, goods, and facilities that are treated as compensation and aswages for withholding tax purposes. Reimbursed expenses, but only when the services for which reimbursement is made areperformed for an employer and

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the employer has not treated the expenses as wages subject to withholding, or where the services are performed for a person other than anemployer and the taxpayer receiving the reimbursed expenses accounts to such person. Recreational expenses for employees who, for this purpose, are not considered highly compensated.An owner of less than 10 percent interest in thepressure cleaning business is considered an employee. An example of this type of deductible entertainment expense would bea company picnic. Expenses of attending a business meeting of a tax-exempt business league, including a real estate board, chamber of commerce, or board of trade.

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Finally, as already mentioned, the maximum deduction for business meals and entertainment has been reduced to 50 percent. Food and beverage costs incurred in the course of travel away from home fall within the scope of this rule. Remember, however, that this 50 percent rule is applied only after determining the amountof otherwise allowable deductions. The portion of a travel meal that is lavish and extravagant must first be subtracted from the meal cost before the 50 percent reduction is applied. Related expenses, such as taxes, tips, and parking fees, must be included in the total expense before applying the50 percent reduction. Allowable deductions for transportation coststo andfrom a business meal are not reducedunder these rules. An employee pays no tax on 100 percent of employer reimbursements made undera so-called accountable reimbursement plan. The new 50 percent deduction limit does, however, apply to the employer’s deductions for the reimbursement amount. At the outset, it was mentioned that the reduction in theportion of meal and entertainment costs allowed for tax purposes would have little effect on the average salon owner or operator. This is best illustrated by the situation of John Doe and his ongoing attempts to convince a potential customer to give his beauty supply operationwork. Late one evening John andhis prospect continuedtheir negotiations at Joe’s Pizzeria.John, inhis role as host, naturallypicked

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up the tab for pizza and drinks, which totaled $24. Under the old tax rules, John could have deducted $19.20 (80 percent of $24) as a meal expense. From now on, John will only be permitted to deduct $12 (50 percent of $24). Since the tax law changes of 1993 eliminated the taxdeduction for lobbyingexpenses, it is unlikely that the big users of meal entertainment expense deductions willhave the financial incentiveto lobby Congress forany changes. However, for the average salon owner or operator, even a limited meal and entertainment expense deduction, complete with all of its limitations, remains invaluableas a salestool and for enjoying the salon business. Asalon owner or operator desiring to get awayfrom it all while, at the same time, learning and keeping abreast of changes in the industry,can combine education with enjoyment at a trade show or convention. Once again, Uncle Sam will pick up a portion of the tab. TRADE SHOWS, CONVENTIONS, AND MEETINGS

So you are thinking of attending a trade show, meeting, or convention? If the expense worries you, or even ifit doesn’t, whynot allow UncleSam topick up a portion of the tab? The rules may be more confusing and the deductions limited under the Omnibus Budget Reconciliation Act Of 1993, but taxsavings remain. T a x Deductions

According to our basic tax law, the Internal Revenue Code, the deduction of trade show or convention expenses depends solely upon whether there is sufficient relationship between the salon owner or operator’s trade or business and his or her attendance at the convention or other meeting. In other words, attendance must benefit or advance the business interests of any taxpayer before a tax deduction can be claimed. Today, expenses are not tax deductible if incurred at events where salon owners or operators do not participate in seminars, discussions, or workshops but are merely furnished with video-

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tapes of lectures on topics related to the beauty business that are to be viewed at their convenience. According to our lawmakers, the use of videotapes or televised material will not automatically result in the expense being disallowed so long as theparticipants are required to attend a convention session in order to view the materials. Employees and conventions create a number of problems, all of which have been addressed at one time or another by our lawmakers or courts.For instance, there is a blanket rule that states there isno tax deduction for travel expenses to a convention or trade show where those expenses are reimbursed by an employer. Of course the amount received as reimbursement is not included in theemployee’s gross income either. The travel expenses incurred by employees in attending a convention held by their employer are not automatically tax deductible. The trade show or convention trip mustbe primarily for business reasons. Relevant factors include:

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The amountof time devoted to business at theconvention or trade show in comparison with the time devoted to recreational and social activities. The location of the convention (e.g., was it held at a “resort” hotel?). The attitude of the employer holding the meeting (e.g., as an award or bonus or for training purposes). The people invited to the convention (e.g.,the employer sponsored this meeting for its employees only).

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If the trip is primarily for pleasure and the employer has paid the employee’s expenses, the employee must reportthe payment received or made on his or her behalf as additional compensation. Expenses incurred in attending meetings, trade shows, or conventions at resort areaswill not automatically be disallowed. But it must be clearly shown that the expenses were incurred for business purposes. Which brings up the question faced by many salon owners and operators: What if the convention trip combines business and pleasure?

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Business or Pleasure?

Whenever salon owners or operators make a trip within the United States that is primarily for business and theyincidentally engage in somepersonalactivitysuch as sightseeing or visiting friends, the travelexpenses to and from the destination are tax deductible. However, if the purpose of the trip is primarily personal, the travel expenses to andfrom the destination are not deductible. Fortunately, regardless of whether the trip is primarily for business or pleasure, any local expenses incurred at the site of the convention that are directly related to the salon owner or operator’s business are tax deductible. Whether a given trip is made primarily for business or personal reasons depends on the individual facts and circumstances. The amountof time duringthe period of the tripthat is spent on personal activity compared to the amount of time spent on activities directly relatingto the trade show,convention, or meeting is an importantfactor in determining whether the trip is primarily personal. If, for example, the salon owner or operator spends one week at a trade show directly related to his or her business and subsequently spends an additional five weeks for vacation or other personal activities,the trip will be considered primarily personal in nature. As mentioned, the tax law includes a provision designed to crack down on a salon owner or operator’s write-offs for the expense of bringing a spouse onany business trip. Fortunately, salon owners and operators may still be able to deduct at least some or all of their spouse’s expenses. Under the old tax rules, a spouse’s trip expenses were tax deductible so long as there wasa bona fide business purpose for the spouse’s presence. But now no deduction is allowed for a spouse’s travel expenses unless there is a bona fide business purpose for the spouse’s presence and the spouse is also an employee of the salon owner’s business. The same nondeduction rule also applies to the salon owner or operator’s dependents or any other person accompanying the salon owner or operator.

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Salon owners or operators are still permitted to write off or deduct what it would cost to travel alone. In other words, the salon owner’s tax deduction may be much more than one-half of the couple’s combined travel expenses. Deductible convention expenses include not only the costs of attendance such as registration fees but also transportation, meals, and lodging while away from home and even local transportation. Transportation costs include the cost of fares charged for travel by air, rail, water, bus, or taxi as well as the cost of renting a car or operating and maintaining one’s own car. In fact, one pilot who used his personal airplane to get to a trade show was entitled to a business expense deduction for the airplane expenses. Generally, no tax deduction is allowed for the expenses incurred for attending a convention, trade show, seminar, or similar meeting held outside the North American area or Jamaica. An exception is permitted if the salon owner or operator can establish that the meeting is directly related to the active conduct of his trade or business and that, after taking certain factors into account, it is “as reasonable” for the meeting to be held outside the North American area as within. Most convention, trade show, and seminar producers are well aware of these restrictions. For the record, the North American area includes the United States, its possessions including the U.S. Virgin Islands, Guam, and American Samoa, the Trust Territory of the Pacific Islands, Canada, Mexico, Bermuda, and Barbados. Only a limited expense deduction is permitted for the cost of attending business conventions and similar meetings on a U.S. flag cruise ship. Of course, the salon owner or operator must establish that the meeting is directly related to the beauty or salon business, that the vessel is registered in the United States, and that all ports of call are in the United States or its possessions. Even after all this additional work and after attaching the required written information statements to the income tax return, the salon owner or operator is limited to a maximum deduction for

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cruise ship conventions of $2,000 ($4,000 on a joint return where both spouses attend qualifying cruise ship conventions). Uncle Sam will, now somewhat reluctantly, continue to help underwrite the expense of attending trade shows, conventions, or seminars. In order to enjoy this financial aid, however, the rules must be followed and records kept. The reward can be a sizable tax deduction, a great deal of pleasure, and even a few benefits for your salon or business. GOODWILL

One of the greatest benefits to small business ownership is the increase in the salon’s value that few are aware of. When a stylist or hairdresser buys a going salon for $100,000, the former owner may report the sale as $75,000 for equipment and fixtures and $25,000 for profits. The buyer, of course, cannot claim that $25,000 profit paid to the seller and so it is usually lumped into the category labeled “going concern value” or “goodwill.” The salon owner or operator who has labored for years to build up the business has a hidden asset that will not be recognized until the business is sold or otherwise disposed of, namely goodwill. Unfortunately, there is no tax deduction or write-off for the goodwill salon owners build up in their businessesunless, of course, the salon is purchased and the price specifically includes a figure for that goodwill. Our tax laws give a deduction to the buyers of salons and other businesses. Buyers can write off what they pay for the seller’s goodwill (i.e., the expectancy of continued customer patronage). According to the basic rules of accounting, the term “intangible asset” is applied to certain long-lived rights and competitive advantages belonging to the beauty-related enterprise. A primary requirement for classifying intangible assets, especially goodwill, is that it be purchased. If, for example, the total price paid for a going concern exceeds the fair market value of the net assets, the excess is considered payment for goodwill.

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Do-It-Yourself Goodwill

On the other hand,a salon that builds up goodwill through successful operations is not justified in adding that goodwill to its books. In the past, so-called intangible assets such as goodwill could be written off only if they had a useful life of a specified number of years. Since goodwill, byits very nature, has an indefinite useful life, no deductions were usually allowed. The income tax treatmentof all intangible assets, not merely goodwill and especially those acquired in conjunction with the purchase of going business concerns, was the source of considerable controversy between small business buyers and the IRS. After all, if any trade or business is sold, the tax rules are quite specific in stating that each asset of the practice is treated as being sold separately. This is true not only when it comes to determining the seller’s gain or loss, but also for determining the buyer’s book value of each of the separate assetsacquired in the sale. Thus, whenasalon is sold, the tangible assetsare assigned a value-real estate, shelving or equipment, vehicles, and supplies. Each are given a value as part of the business. This value is used to determine theseller’s gain or loss and to establish the book value of the various assets under the new ownership. In other words, the purchase price of the salon must be allocated among the assets, other than goodwill and going concern value. The remainder is assigned to goodwill and going concern value. This so-called residual method is mandatory for sales of assets to which goodwill could attach aswell as salesof a group of assets thatconstitute a trade or business of either the buyer or seller. The buyerand seller of a salon or beauty-related business are allowed to agree, in writing, to an allocation of part or all of the consideration involved in the transaction and of the fair marketvalue of any assets transferred. Thatallocation will usually be accepted by the IRS so long as both parties arebound by the agreement. The IRS does, however, reserve the right to determine if that allocation is appropriate.

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Tax Rules In an attemptto reduce the controversy betweenbusiness buyers and the I N , the taxlaw now provides specific amortization rules for acquired intangible assets, not only goodwill.In general, salon owners and operators will amortize or write off the cost of most acquired intangible assets (including goodwill) over fifteenyears. Unfortunately, the tax rules apply only to acquired intangibles whether or not they are acquired as partof a going business.The treatment of self-created intangible assets remains unchanged. That is, they remainnondepreciable capital assets. Suppose that Lucy Jones buys the XYZ Salon. Of the $250,000 purchase price, $42,000 is allocable to goodwill. Under the old rules, Ms. Jones would not get any write-offfor her $42,000.Instead, the $42,000 would reduce her taxable profit, if and when X Y Z Salon was eventually sold. Now the cost of an intangible asset such as goodwill is written off over fifteen years beginning the month in which the asset is acquired. The deduction is allowed evenwhen thereis no way to gauge the trueuseful life. Under the present tax rules, Lucy Jones can write off the cost of goodwill over fifteen years at the rate of $2,800 per year. The goodwillwrite-off rule applies to intangibles acquired &r August 10, 1993. However, because the law was made retroactive, salon ownershuyers can choose the new fifteen-year writeoff for all intangibles acquired between July 25,1991, and August 10,1993. In other words, buyers who acquired a business or practice with allocable goodwillin late1991or in 1992 can file amended incometax returns andclaim deductions for goodwill. Remember, however, if retroactive application of this provision is chosen (and the salon owner or operator has three years from the date theoriginal tax return was due to do so) all acquisitions of intangible property must be covered. Those buyers who made acquisitions after July 25, 1991, must carefully consider whether toelect to apply the new law retroactively. This analysis or planning must consider all acquisitions after July 25, 1991, (including those of certain related entities)

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and will weigh a number of factors such as the amount of the purchase price that could be allocated to amortizable intangibles (e.g., patrodcustomer lists), the write-off period of those intangibles, and the amount of goodwill. The salon owner or operator must also weigh the value of the certainty provided by retroactive application of the new law. To illustrate the potential problems that continue to plague those who acquired salons before the passage of the 1993 law, consider the following example. On July 1, 1993, X sold all of the assets used in its salon to Y. The assets consisted of real estate, a customer list, goodwill, and a covenant not to compete. Under prior law, the real estate would be depreciated over 31-1/2 years (39 years if the acquisition occurred at a time subject to the new rules). The customer lists would be amortizable if Y could support the amount of the purchase price allocated to its value and prove that it had an ascertainable useful life. The covenant not to compete would be amortized over the duration of the covenant, three, five, seven years, or whatever. If the acquisition took place under the present tax law (i.e., if Y elected retroactive application of the amortization provisions), the depreciation period of the real estate would not change and would not affect the analysis. The customer list, the covenant not to compete, and the goodwill would all be amortized over fifteen years, regardless of how they had been treated earlier. Thus, in order to benefit from the retroactive feature of the intangible write-off, all intangible assets regardless of their useful life, would have to be lumped under the new fifteen-year life. If the covenant not to compete were allocated a significant portion of the sales price, increasing the period of time over which it was written off would reduce the annual tax deduction in this area. The fifteen-year write-off period also applies to many other types of business intangibles, as long as they are purchased by the salon owner or operator and not self-created. For example:

. .

Copyrights and patents acquired in connection with the purchase of a business. Franchise, trademark, and trade names.

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Information bases, such as customer files, customer lists, and direct mail and telemarketing lists. Contracts with customers or suppliers (unless the contracts have a fixed duration and are nonrenewable). Computer software acquired in connection with the purchase of a business and not available to the general public. (Other sofiware can be written off over thirty-six months.)

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All salon owners and operators will amortize the cost of acquired intangible assets (including goodwill) ratably over fifteen years. The law applies to all acquired intangibles regardless of whether they are acquired as part of a going business. The goodwill deduction is a first, but only the salon owner or operator can tell whether its negative aspects will help or hurt. Goodwill itself, of course, is a hidden asset of many salon operations and is to be considered yet another benefit of ownership. The tax deduction for goodwill acquired as part of the purchase of a salon is merely icing on the cake for many.

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CHAPTER NINE

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Growth has been a way of life for most salon owners and operators. In fact,were it not for almost constant growth, many wellestablished salons mightno longer bein business today. After all, in today’s competitivebusiness climate, the alternative to growth is stagnation, and few stagnating salons can hope to survive. Unfortunately, the basic question of when a salon can afford to expand or growis another of those business questions for which there is no cut-and-dried answer. Faced with all the variables in the operation of every salon, perhaps the question should be when cana salon owner oroperator not afford to grow orexpand? Assuming for the moment that the question of when a salon owner or operator can afford to expand or grow can be answered by another question of when it cannot afford to grow, let’s explore the financial aspects of a growth strategy. GROWTH STRATEGIES

According to the textbooks, growth can be accomplished either from forces within the business or through combinations with other businesses,new orexisting. Among the internal forces that drive many salon owners and operators to expand or grow are our tax laws. Our tax laws contain provisions that penalize any salon that accumulates excessive earnings withinthe business. Quite simply, any incorporated salon that accumulates earningsin the business beyond what the IRS defines as its “reasonable needs” faces a penalty tax over and above the regular taxes already imposed on those funds when they were originally earned. Naturally, the owners of that incorporated salon can distribute those accumulated earnings either in the form of dividends or increasedsalaries andbonuses to principals. However, any dividends distributed will be taxable income to the recipient. Unlike dividends for which a corporation is not permitted a tax deduction, bonuses and salaries are deductible by the salon operation although, again,the recipient will normally be subject to tax on the personal level.

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Just as theincorporated salon can be penalized for accumulating earnings beyond the “reasonable needs of the business,” paying excessive salaries to principals in the salon operation is also subject to penalties. Using those accumulated earnings for growth or expansion will, in most cases, not only avoid the accumulated earnings tax, but also generate additional tax deductions, even if only forannual depreciation allowances. New Equipment/Building Improvements

Putting additional money into the business, be it reinvesting those accumulated earnings or using cash flow, borrowed money, or additional funds from investors, allows the salon to grow in a variety of ways. The acquisition of new or additional equipment will, of course, result in an annual depreciation allowance spread out over the period our lawmakers have decided represents the useful life of that newly acquired equipment. Even equipment repairs or improvements to the business premises is a form of growth. Repairs, modest remodeling, and upgrades usually constituteexpenses rather thancapital expenditures. Thus, they are immediate tax write-offs. Capital expenditures, at least all but the first $17,500, must be written off or deducted over the prescribed depreciation period. And should new equipment acquisitions exceed $200,000, even that Section 179 first-year expensing deduction will be reduced. The depreciation rules contain a provision that denies a depreciation deduction until the asset is actually placed in service. Under those depreciation rules, our lawmakers allow a shortcut whereby all equipment or assets acquired during the course of a year may be assumed to have been placed in service at midyear. One-half of one year’s depreciation allowance is generally allowed regardless of when duringthe year that asset wasactually placed in service. New Businesses

Owners or operators who attempt to grow or expand their salons by starting new businesses may be faced with a similar restric-

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tion. To anyone not already in business, the expenses incurred investigating a new business start-up are not tax deductible. That includes the legal fees for forming the new operation, the accounting fees for setting up the books of that new business, the money spent acquiring premises for that new operation, and the assetsthat will be used in that new business. All of those so-called start-up expenses must be capitalized and can only be writtenoff or deducted over a sixty-month amortization period beginning with the month the new business actually beginsoperations. Whether a salon owner or operator already in business will be permitted to immediately deductthe expenses of starting upa new venture is another question without a specific answer. If the new business is closely related to the existing venture, perhaps the expenses of starting it up would be legitimate business expenses and quickly deducted. Ifthe relationship orsimilarity between the existing and thenew operations are more disparate, the ever-vigilant IRS might choose to view the start-up as unrelated and require the sixty-month amortizationof those expenses. As an alternative to the addition of new equipment ora new start-up, many salon owners and operators choose the route of business combinations. Although the passage of time has blurred the exact meaning of many types of business combinations, generally a merger is a business combination in which two or more entities join together withone being fused into the other. Mergers

A consolidation is a combination in which two or more entities join together and go forward under a new name or a new legal form. An acquisition (or purchase) is a combination in which lib tle or no effort is made tocontinue in existence the identity of the acquired company. An acquisition can take theform of a merger. Naturally, taxes rear their ugly head in these situationsas well as most other business decisions. However, unlike the tax penalties imposed foraccumulating earningsrather thaninvesting in the salon operation’s growth or the deduction limits that apply to growth through adding equipment, employees, or addi-

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tional space, growth or expansion through these so-called business combinations is normally tax free. But the combinations must be properly structured inorder to benefit from this unique tax-free status. Under our tax laws, no gain or loss is recognized or taxed if stock or securities ina corporation that is a “party to a reorganization” are exchanged solely for stock or securities in that corporation or in anothercorporation that is “a partyto a reorganization.” In other words, most business combinations qualify as corporate reorganizations and,as such, are generally tax free. So far we have explored the various incentives: growth for survival, or grow or be taxed, as well as a few of the taxpenalties that might befall an expanding or growing salon. On the surface it would appear that growth through a tax-free merger or other tax-free acquisition strategy offers the most attractive course of action at least from a tax perspective. But it fails to really answer the basic questionof whether a salon canafford to grow or expand. The majority of salon owners and operators have an expansion or growthoption of which they arecompletely unaware. It is, as many successful businesses have discovered, possible to grow or expand withinthe existing framework of the salon operation. GROWING IN PLACE

Many manufacturers have learnedthat operating a given piece of equipment for longer than a normal working day increases production a t only a fraction of the normal overhead costs. Going one step further, itis oRen possible for a salon to merely add a part-time workeror extend the hoursof operation. Immediately, income is increased without the need to invest additional funds in the salon operation. Adding Employees

To grow beyondthe stageof merely having created a job from for themselves, salon owners must add employees. Adding employees

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can take manyforms. It can be as easy as adding a partner with skills that complement those of the owner. It can be providing space in the salon for an independent contractor offering services that complement or supplement those alreadyavailable in the owner. Or, more frequently,it can mean addingsomeone to the salon’s payroll. The first question to be asked is if there is sufficient need for the addition of a partner, independent contractor, or employee. Will the addition increase the operation’s incomeenough to cover the costs of adding that person? A salon that adds a nonproductive employee such as a bookkeeper, receptionist, or maintenance person to thebusiness hopes that the addition will free up enough of the principal’s or productive employee’stime to pay for itself. But,this is not always the case. A salon owner who is presently bringing in $1,000 a week may increasethe weekly income by$500 by hiring a nonproductive employee/assistant. On the surface, paying $300 or $400 per week to that additional employee in order to reap an additional $500 might appear prudent. Butnot when we talk about “net”income. An owner who brings in $1,000 a week often forgets that that gross income must be reduced by overlooked costs and supplies. Paying rent and utilitybills of $1,000 per month reduces that $1,000 weekly gross by $250. Supplies further reduce that total as do expenditures for advertising, telephone, office supplies, cleaning, insurance, and thelike. Plus, there is the bookkeeping allowance for wear-and-tear on the salon’s fixtures and equipment, otherwisecalled “depreciation,” that further reduces the “net”income available for that nonproductive employee. If the income remaining after allof these fixed or overhead expenses is sufficient to compensate a nonproductive employee or carrya productive employee until such timeas the additional income brought in is sufficient to reward him or her, then the actual cost of that additional person must be considered. Under ourSocial Security system, old age and disability insurance, together withMedicare and unemployment insurance, are financed through payroll taxes. Old age, disability, and Medi-

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care are financed by taxes levied on both the employer and the employee and paid to the federal government. Unemployment insurance is financed almost everywhere by taxes on employers alone. Other liabilities associated with this additional payroll include a wide variety of deductions made by agreement with employees as well as, a t least in some cases, payments to pension, health, and welfare funds. Union dues, savings plans,and insurance plans addto the payroll nightmare andcost of adding employees. In addition to the direct payroll costs and the cost of any fringe benefits, the salon must also bear the expense of making those payments and maintaining the required records. Plus, there are the many informational returns andreports that must be prepared by the salon owner or someone employed to handle these time-consuming chores. And, finally, there are the less noticeable costs associated with adding others to the salon operation. Additional space for that person to work in, higher utility costs, more supplies, and even the additional cleaning required all cost money. Those fiequently overlooked expenses added to the cost of payroll and payroll taxes compared to the net income available to cover them provides an accurate picture of whether the operation can realistically hope to add anyone to the payroll. With internal expansion such as overtime or adding that additional shift, salon overhead remains almost at thesame level as previously. Additional labor and supervisory personnel may have to be increased, but increased receipts should cover most additional wages and supply costs without affecting overhead. Internal Reorganizations

Internal reorganizations, even in larger, unionized salons, are also a method for growth or expansion. Redefining jobs, asking employees to be more productive, slashing management levels, or even creating sales or production incentives to improve profitability mightbe considered growth or expansion strategies.

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When all is said and done, growth and expansion is not really a questionof affordability. Rather, it is aquestion of survival. Either grow and expand or remain stagnant andeventually fail. The question, then,is how best to grow or expand. Growth and expansion should always begin by fine-tuning the existing operation. Without a productive and profitable operation upon which to build, no salon can hope to expand or grow with acquisitions of additional equipment, personnel, new shops, or even through business combinations or new business startups. So look at the existing operation. Is it asprofitable as itcould be using existing facilities and equipment? Is it providing the maximum amount of bottom-line profits as possible considering the amount invested? Is everyone in the operation performing as well and effectively as they can? Can your salon afford growth or expansion? How can it not afford to expand or grow, especially if that existing business operation is not all that itshould be production- and profit-wise? MANAGING FOR GROWTH

The most successful salon owners or operators are not always the best at what they do or even the most knowledgeable. In fact, successful salon owners or operators may noteven be very good hairstylists. But chances are they are very good managers. And those successful owners and managerswill tell you that the profits from properly managing any salon operation can dwarf the profits from the cash register. Need proof? The average hairdresser opens the salon doors, serves the salon’s customers, occasionally sells beauty products, orders more goods, cleans up, and closes the doors for the day. Profit equals total receipts less the cost of labor employed, goods sold, and overhead. What could be easier? But what about the effect of inflation? Suppose, by way of illustration, that you open a $10,000.00 savings account that earns7 percent interest. Not a greatinvestment but adequate for purposes of our illustration; $10,000.00,

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after all, will buy $10,000.00 worth of goods today. Remember, however, that the$700.00 (7 percent interest on $10,000.00) will be subject to income tax. At a 28 percent tax rate that $700.00 interest will be reduced by $210.00 to only $490.00 forthe year. So the net return from your savings account is 4.9 percent in aftertax dollars. Unfortunately, inflation enters the picture. First, that $490.00 return on the $10,000.00 savings account will actually only buy $460.60 worth of goods ifinflation has been rising at a 6 percent level. Plus, don’t forget that that original $10,000.00 will now buy only $9,400.00 worth of goods. That means that in today’s dollars, the account including reinvested interest is worth only $986.06. The same insidious eating away occurs at the value of the assets employed in the salon. Maybe the rate of return on the funds you have invested in your salon is higher (or lower), your tax rate falls into another bracket, and the rate of inflation is different in your geographical area. But the net, bottom-line effect is the same: good, productive management isnecessary to preserve and increase both the value of the assets employed in that operation and theprofits it earns. How can the average salon owner or operator successfully manage matters not only to maintain the yield of the business but also to increase it to compensate for inflation? Wete already touched on two important areas that deserve attention, taxes and investment. Managing Taxes

First, taxes should be managed. That means weighing the effects of all business decisions on the operation’s tax bill. The average tax rate paid by most salons is approximately 34 percent, and sole proprietors usually pay an average tax bill of 36 percent on comparable income. Properly handled, saving34@to 36q! in taxesfor every dollar spent in thesalon business adds up. After all, if you buy a new cash register for $100 (hypothetically speaking, of course), and can increasethe annualdepreciation write-off by$1,that means

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either 3 4 more ~ in your pocket or 3 4 less ~ that mustbe borrowed at 9 or 10 percent interest tobuy that cash register. Managing Investments

In the investment area, it is obvious that the combined effect of inflation and taxes on our savings account will eventually reduce the purchasing value (if not the actual balance) to near worthlessness. The same istrue with any business. A salon that uses the same equipment and fixtures year after year is rewarded with more bottom-line profit. However, when the depreciation deductions run out after five or seven years, the salon must pay taxes on the business income that is no longer offset by those expended depreciation deductions. This assumes, of course, that thereis any businessincome remaining since shoddy businesses produce less and less income as time goes on. An alternative is to constantly replace and updatethe equipment and fixturesemployed in thesalon operation. Not only will this type of investment keep the customers happy, a side effect might be a more efficient operation. When equipment is purchased at today’s prices, the money borrowed forthat purchase will be repaid in tomorrow’s dollarsworth considerably less than when they were borrowed. The depreciation deduction, at least under our present system, is weighted to produce bigger write-offs in the early years of the asset’s life when the deduction is needed more and thevalue of the dollar is higher. BORROWING FOR GROWTH

As already pointed out, taxes and reinvestment in thesalon operation are intertwined. So, too, is borrowing. The old adage states that bigger profits can always be achieved using other people’s money. That may havebeen true before interest ratesskyrocket+ ed in the 1970s and 1980s. Today’s lower interest rates are far more affordable, but money is not always available. Thus, yet

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another strategy for managing the profits of the salon is aggressive borrowing. Aggressive Borrowing

Aggressive business borrowers usually know far inadvance that funds will be needed by their businesses. Salon owners are also usually aware of exactly what thefunds will be needed for, how much will be needed, and, most importantly, how the borrowed funds will be repaid. Consider these points. A good manager projects business income and expenses into the futurebased on past performance. Sure it’s guessing, but guessing based on the past, experience, and other facts. Thus, the salon owner or operator can see when additional working capital might be needed somewhere down the line or when it might be advantageous to borrow in order to buy new equipment that might help increase receipts in the future. And since the owner or operator always has the figures, it is not difficult to see just where the extra funds will comefrom to repay anyborrowing. If an astute manager,salon owners or managers don’t automatically turn to their bank for those needed funds. After all, there are otheroptions. Bypassing the Bank

Self-financing is one alternative, asis taking in a partner, selling stock, or even borrowing from sources other than a bank. If, however, the best source of funding is a bank, good managers know that everything is negotiable-interest rates, terms, the length of time the funds will be held, and the extent of extra bank services that will be used as aninducement to the banker to loan thosefuture funds. Having mentioned that projecting future cash flow often permits self-financing, a warning about reserves is in order. Many of us, in our personal lives, tuck away money for a rainy day, for a new car, or for whatever reason. In business, many salon owners and operators also put money aside for future use.

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Those reserves, be it for insurance payments, property taxes, expansion, new or additional fixtures or equipment, or whatever, all have one thing incommon-they are not tax deductible. That’s right, even though the funds have been earmarked for a specific, business-related purpose, they are reserves. And fewreserves are tax deductible. In fact, creating reserves or merely keeping money in the business can have anadverse effect on the salon operation. Don’t forget about that “accumulated earnings tax”we citedas one reason for growingor expanding the salon operation. Accumulated Earnings Penalty Tax

That accumulated earnings tax is nothing more than a penalty for any incorporated salon that retains too much money in the business operation. So beware, reserves are not tax deductible. If the salon business accumulates too much money it can be penalized. If it attempts to pay out those accumulated funds as additional salary for the principal(s), be aware that penalties also exist for excessivesalaries. If the money is properly paid out as a dividend, it is, naturally, subject to tax at the personal level (having already been taxed at thecorporate level). So the good manager keeps tabs on the future aswell as thepresent income and expenses. As part of keeping tabs on current expenses, it is almost second nature to ask the question: can I do this or acquire that less expensively? Look at those leased business premises, for example. ADVERTISING

Finally, good management also means taking a closer look at the basics such as advertising. If a business can spend $10 in advertisingto attract ten prospects of whom three actually spend $10, is that business going to prosper? If the services sold to those three customers are less than $20, the salon will lose money because no consideration has been given to overhead

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expenses-thecost of opening the doors and turning on the lights every day. A good manager knows these costs and can routinely tell whether any expenditure-foradvertising or whatever-will pay. A good manager will also know that it is far more profitable to attract more prospectswith that $10 ad, lesscostly to try andconvert more of those prospects into customers, and more profitable to increase the amount each customer buys than to simply increase the ad budget. That is called good management. During today’seconomy, more and more large companies have discovered that their treasury operations can produce more profit than theirbasic line of business. So, too, many salon owners and operators are beginning to realize that profit can come from many sources, both fromthe business and from better management. GROWTH FINANCING

The increasing trend toward more, bigger“superstores”has forced many salon owners and operators to attempt to grow their own operations in order to compete and tosurvive. Unfortunately, even without today’srecordlow interest rates, many salons cannot afford moreequipment or additional employees, let alone a larger or remodeled salon. Theymust finance. Conventional sources of financing such as banks, havenever been the cure-all for every financing need despite the largenumbers of salon owners and operators who use them for every type of financing. With problems of their own and withso many regulators looking overtheir shoulders, those banks do offer extremely low interest rates,at least to those few whocan still qualify under their tightlending policies. Banks have always been and still are anexcellent place for a thriving business to seek short-term funds. For loans for periods of less thanfive, six, or seven years, the convenience and low interest rates of a bank simply cannot be beat. For a troubled salon, however, banks provide a wide variety of financial services and counseling that can be of tremendous help to any

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owner or operator feeling the pressure of bigger and betterfinanced competition. The local bank is also the first stop when seeking financing from another conventional lender, the U.S. Small Business Administration (SBA). The SBA rarely makes direct loans any longer. What they do, instead, is offer banks a guarantee that a borrower will repay any money loaned to them. The SBA guarantee often reduces the bank's already low interest rate and helps make loans available to new and existing salon operations whose financial history or lack thereof might otherwise disqualify them for conventional loans. Once again, however, SBA financing, like bank funding, is normally for a relatively short period of time. This means the borrowed funds are more expensive than long-term borrowing and must be repaid within a relatively short period of time thereby further reducing the cash flow of the already strained salon operation. Many beauty product distributors and wholesalers provide financial counseling. In addition to advising owners or operators on how to grow their salon operations, they can direct the salon owners or operators to available financing programs. In many cases, those wholesalers and suppliers may even provide direct funding for special needs. Fortunately, many salon owners and operators can directly access many of those same funding sources used by their wholesalers and the larger salon operations with whom they are trying to compete. Take those local, state, and regional financing authorities, as one good example of not-so-conventional financing. Government Money Whether called an industrial development authority or small business development organization, these government and quasigovernment agencies have one thing in common-they exist solely to help businesses such as salons and to bring (or keep) jobs in the area of their operation. In the past those agencies could sell bonds and use the proceeds to directly finance a new plant or business. Several years

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ago, however, our lawmakers in Washington, D.C., severely limited many of the tax breaks that made industrial development bonds so popular. Today, instead of utilizing the development agency’s powers to sell tax-exempt bonds, the proceeds of their bond sales can be split up among a number of smaller businesses, even nonmanufacturers. What remains in our tax laws is a provision that permits those agencies to provide bond issues featuring the low interest rates of tax-exempt government financing. Instead of one business firm per issue, however, the new offerings raise money those agencies turn around and lend to a number of small, growing, or new businesses in their areas. Most salon owners and operators stop at the local bank for advice about short-term conventional financing and the probability of SBA loan guarantees. The next stop for many is the office of the appropriate state or local industrial or business development agency. But there are still more financing possibilities. Going Public

I

Several years ago the Securities and Exchange Commission relaxed their rules governing firms that wanted to “go public,’’ that is sell their stock to the general public. Although few owners or operators can hope to see the stock of their operation traded on one of the many stock exchanges, those relaxed rules make it relatively easy and inexpensive to legally issue and sell stock in the salon business. An incorporated salon may already have a number of shareholders, usually members of the principal’s family and a few key employees. Thus, many salon owners and operators already understand the headaches of having to answer to others with an interest in the business. Bringing in an investor in order to get the financing needed to grow the salon operation is usually quite effective despite the control lost. After all, a shareholder in a small salon is more likely to be content to wait for profits or to wait to profit from sale of the stock in the enlarged or more profitable operation several years

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down the road. In essence, selling stock in the salon operation can be compared to relinquishing a portion of control in order to obtain growth funds upon which no interest need be paid (in the form of dividends). Acquiring a Partner

Far simpler than issuing stock is bringing a partner into the salon business. The owner or operator is still relinquishing control, still incurs legal fees, and, in return, gets badly needed financing for which no interest need be paid. But, depending on the partner, sharing control may prove to be more costly than answering to a large number of shareholders. Salon owners or operators who believe they must grow in order to compete still have another source of financing: the salon business itself. Equipment/Property Leasing

Many salon owners and operators routinely lease equipment or even the business premises. Leasing equipment and other property reduces the out-of-pocket costs of acquiring those assets. However, leasing falls into the category of short-term financing except when the leasing rules are exploited to their fullest. Consider the salon owner who is facing stiff competition from a much larger salon chain nearby. The independent salon owner may frequently feel that the best way to compete and, hopefully, survive is to grow larger also. The present need is not so much for additional equipment. Rather, larger or remodeled business premises appear to be a priority. Handled properly, it is feasible, legal, and often quite profitable for a salon t o sell its assets and lease them back from the buyer. Imagine selling the shop building to a group of investors. The salon operation gets cash and incurs an obligation to pay rent. The investors get a return on their investment, a number of tax benefits, and no say in the operation of the business.

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TAX CREDITS

Tax credits, rather than tax deductions that merely reduce the income upon which the annual tax bill is based, directly reduce the final tax bill. As already mentioned, a number of major expenditures made to comply with the Americans with Disabilities Act result in a special tax credit. Rehab Tax Credits

Tax credits that can help the salon operation “grow,”come from a unique tax credit for expenditures made to rehabilitate the business premises. The rehab tax credit means a direct reduction of the salon operation’s taxes of 10 percent of all money spent to rehabilitate or restore older business buildings. A special 20 percent tax credit is available for improving business buildings (and some residential property) that is either registered historical property or located in an area that is listed in the federal register as a historic district. Employee Stock Ownership Plan

Not quite as restrictive as the rehab tax credit, another section of our tax law has helped many raise growth money. Under our tax rules, it is possible for the owner of a business to establish an Employee Stock Ownership Plan (ESOP). The newly established plan borrows money that it uses to purchase a portion of the stock of the employer/salon. The salon operation gets an immediate infusion of cash from the sale of its stock while contributions and earnings distributed to the ESOP reduce the ESOP’s debts. Eventually, the employees directly own a portion of the stock in the salon or business. Raising the money needed to grow any business for survival and increased competitiveness is a process that deserves a great deal of thought. The result can often be inexpensive financing that can be repaid from the operation’s increased cash flow and from exploiting all available tax provisions.

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Although touched on briefly before, every growth strategy should include some of the assistance provided by the U.S. Small Business Administration (SBA). SBA GROWTH HELP

For all of those many salon owners or operators who may have experienced difficulty obtaining a small business loan f?om the bank or for those who find that even today’s low interest rates are more than they can afford to pay, the U.S. government’s Small Business Administration may be able to help. Thanks to a rocky history, a great number of broken promises, and the all-too-familiar political bluster, the SBA is either ignored completely or avoided because of what many feel will be bureaucratic red tape. Surprisingly, however, the often misunderstood, under-funded Small Business Administration is an excellent source of affordable financing-even if they, themselves, don’t have the funds. Types of SBA Assistance

The SBA provides financing assistance in four general areas: 1. Venture or risk capital 2. Business loans 3. Disaster loans 4. Performance bonds

Money for venture capital is made available through the Small Business Investment Company (SBIC) program and the Certified Development Company program. Business loans (and farm assistance loans) are made available under a variety of programs whose policies frequently change under different administrations and congressional budget restrictions. Basically, these business loan programs provide 90 percent guarantees to commercial lenders, or, in the best of times, provide direct funding from the Small Business Administration.

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Disaster loans for natural disasters, not the salon owner’s personal or business disaster, are authorized by the president and provided by the SBA as direct grant loans to repair or replace damaged property and/or to recover from economic damage. Performance bonding guarantees are provided by the SBA to small firms unable to obtain bonds for work on government contracts. SBA LOAN PROGRAM

Obviously, the SBA loan program will be of the most interest to the majority of salon owners. The SBA currently offers loans to furnish working capital, purchase equipment, supplies, or inventory, purchase land or buildings, and fund new construction and/or expand or convert existing facilities. Financial assistance is also offered for nonrevolving lines of credit for seasonal inventory purchases and contract financing. Revolving credit is available for export-related firms. In most cases, the SBA will not fund debt repayment, so their money cannot be used to reduce an existing debt. Nor can the salon owner or operator use SBA loans to pay delinquent IRS withholding taxes, sales taxes, or similar funds held in trust. SBA loans or loan guarantees cannot even be used to replenish funds that were used for this purpose. Continuing on a negative note, financial assistance is not extended to applicants involved in the following categories: speculative, nonprofit institutions, newspapers, magazines, book publishers, and gambling. Other ineligible applicants include movie theaters, TV and radio stations, cable TV,lending or investing, real estate, monopolies, pyramid sales plans, and owners who are currently incarcerated or on probation or parole. QuaIificat ions

According to the SBA, they require that all applicants demonstrate good character. Criminal records or other infractions are investigated thoroughly. Plus, owners and officers of the salon

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operation must demonstrate management andtechnical ability to reasonably assure thesuccess of the business. Those salon owners and operators who qualify and wish to apply for SBA loans must be so-calledsmall businesses that are not dominant in theirfield of operation. They must also fit within the following parameters established by Congress to define “small business”:

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Retail and services. These businesses must have average annual receipts of $3.5 million or less (average of three years). Wholesale businesses must have one hundred employees or less. Manufacturing companies must employ fivehundred or less.

Naturally, there areexceptions to these general standards, so the salon owner or operator should be sure to consult the SBA for the current specific guidelines. For those salon owners and operators who do qualify, the next question is, how much? Amounts and Guarantees

When SBA funding is available, direct loans are limited to $150,000 to anyone business (and its affiliates). The SBA is permitted toguarantee 90 percent of a bankloan if the total amount is $155,000 or less. Guarantees on loans in excess of $155,000 are limited to 85 percent with $750,000 as the SBA’s maximum exposure. The guarantee, far from being just another layer of paperwork, usually results inlower interest rates anda greater availability of funds. Although each application is reviewed on its individual merits, the SBA does not normally consider lending 100 percent of the funds needed to start any new salon business. Personal Investment

The borrower must have a reasonable personal down payment amount a t stake, generally around 30 percent or more of the

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funds necessary. For highly competitive salon operations or those with high failure &ti%