Credit Card Expenses
When valuing a business, professional business brokers are often confronted by a vexing problem; credit card expenses. The business owners have been using the credit cards for both business and personal purchases. The problem becomes more challenging when the business owners neglect to categorize these purchases.
Small business financing company Fundera recently released the results of a survey assessing how small and mid-size business owners make purchases for their companies. Fundera’s report revealed how common it is for small business owners to use their business credit cards for personal expenses, a practice that can lead to, among other problems, financial, tax and compliance-related consequences. But it is also likely to impact the value of the business when it comes time to sell – and it will come time to sell – or arrange for some financing.
According to Fundera, 23 percent of surveyed small business owners admitted to mixing personal and business expenses on their commercial cards, with meals and small-value purchases such as tires for the kid’s car the most common personal transactions landing on business credit cards.
Researchers pointed to a lack of adequate cash management strategy as a top reason why business owners make this mistake. But it’s a phenomenon we see all the time; some business owners simply don’t think to make the distinction between personal and business purchases. So, how can this impact the perceived value of your business?
First, let’s make clear that if you are one of the rare individuals that are anal enough to categorize each expense on your various credit cards every month, congratulations! You may be able to avoid the confusion that can result from using a card for both business and personal expenses. But most people are not that organized. And when we get asked to value a business, this disorganization can cause 1) confusion, 2) the cost of the valuation to rise and, 3) the valuation’ conclusion itself to be inaccurate – and usually lower than it would be if the credit card records were either clear or, better yet, separate.
Problem #1: An Accurate Valution
We had a client recently that came to us interested in selling. As is our iron-clad rule, we required that an estimate of the business’ value be done so that both our broker and the business owners could see what the Most Probable Selling Price (“MPSP”) was. Our guy requested the information necessary to value the business and the owners provided what they had, which was most of what we needed.
As we were examining the income and expense statement, a very curious expense stood out. It was labeled “Business Credit Card” and, over the three most recent years for which we had financial statements the total expense for this “Business Credit Card” category ranged between $60,000 and $120,000 annually.
One of the newest members of our team jokingly (I hope) said that he’d never heard of a credit card costing that much money but, as you’ve probably figured out, the business owners were charging $5,000 to more than $10,000 every month to the card and writing one check, the amount of which was whatever the amount on the statement said was due.
It didn’t matter that there were dozens of transactions – maybe for meals, maybe for fuel, maybe for office supplies; or maybe for running shoes for the owner’s son the future track star; or a couple of thick-crust pizzas for the family every Friday night; or a pair of front tires for the daughter’s car – but none of these expenses were categorized. The monthly check that was issued to pay the card balance was, of course, made payable to the card company rather than the vendors that supplied the products or services purchased.
Affecting the Valuation
This affects the valuation in two ways: 1) the cost of the valuation and 2) the result of the valuation.
- Valuations can be done by certified business appraisers, some accounting firms and professional business brokers, preferably CBIs. I am a Certified Business Intermediary, a certification from the International Business Brokers Association, and the assignment of this business’ valuation landed on my desk. Without requesting copies of each credit card statement, going through each of them line-by-line, conferencing with the owners to get an explanation of any charge about which there is a question – and that was most of them – there was no way to tell what was bought for the business versus what was bought for personal benefit. And this is an extremely time-consuming task and few business brokers will go through the process without getting paid for it. I certainly won’t!
- In the case of our clients, they did not want to pay for our team or their accountant to go through all the statements, classify all the expenses and then re-run the financial statements. Without doing such detailed analysis, we were unable to determine if any of the expenses were for personal items (two front tires for the daughter or $1,500 for pizza for example). As such, it was assumed that all the expenses were business related. If, during the process of recasting the business’ earnings, we were able to identify personal expenses, we would have then been able to adjust the total expenses and arrived at a higher number for the company’s discretionary earnings – and thus a higher MPSP.
If the sellers had been willing to pay their accountant or us the extra $1,000-$1,500 that such a clean-up would likely have cost, there is a reasonable chance that the MPSP of their business could have been $50,000 to $70,000 higher than our ultimate analysis suggested it was.
Even if the business owners use one card solely for business and to the exclusion of all other cards, the expenses must be tracked so that the owners, their accountants and the business broker hired to establish a MPSP can determine what categories – office supplies, business dinners or anything else that goes on the card – each respective expense is to be applied to. And, at the end of any given month or quarter or year, how can an owner analyze his or her true expenses – as a percentage of revenue – if they don’t know exactly what money is going where?
Knowing what you’re spending – quarterly or annually – as a percentage of revenue is an immensely useful bit of data to have when you’re trying to increase your bottom line. You can identify places where you can cut back – and every dollar that is not expensed goes into the owner’s pocket.
In the 1970s or ’80s, American Express pioneered business cards that would track your expenses by category and at years-end the business owner would receive a statement of the card activity completely categorized. Many banks and non-bank card issuers followed suit. Taxes, accounting and basic financial management were made demonstrably easier with these cards but the business owner has to use them – and only them.
This issue gets even dicier when we start considering the new ways of paying for things using our mobile phones when they are equipped with such tools as Apple Pay, Samsung Pay and the like. Unless the business owner is diligently tracking his or her expenses and separating them first into “business” and “personal’ categories and then slotting the business expenses into their respective and specific categories, the problems above will be the owners’ personal companion every tax season (and the broker’s headache when doing a valuation), the costs to prepare the business’ and the owners’ taxes will be higher than necessary and the chance of getting an accurate estimate of the MPSP of the business when it comes time to sell will be much less likely.
And, if the numbers are large enough, a red flag may be raised down at the friendly regional tax office and someone that nobody wants to hear from will start spending and uncomfortable amount of time with the business owners and their accountants.
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The Bottom Line
Aside from the clarity that is provided when it comes time to sell, there are many other benefits to having a business (that is, “business specific”) credit card. Such benefits include earning rewards points or cash back that can go straight into the business. But even with a credit card dedicated to business expenses, if the expenses are not properly and carefully categorized, neither the owner nor the business broker will have any idea what was really spent on T&E, office supplies, fuel, conferences and dozens of other line items, information that is crucial to the running of a business.
If you have any questions, comments or feedback on this topic – or any topic related to business – I want to hear from you. Put them in the Comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a profitable week!
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