Mastering the art of strategic planning
As most businesses grow, strategic planning evolves from a few ideas in the mind
of the owner to a more formal process. Sometimes a consultant is brought in, and
eventually a formal strategic planning document is developed that lays out key
initiatives for the business over the next three to five years.
Unfortunately, what starts out as a well-articulated set of strategic directions
often ends up collecting dust — not meeting its potential to help drive the
business’ success. So how can you make sure your strategic plan grows with the
company?
It’s a process, not a document
The strategic planning process should involve collecting relevant facts, setting
priorities, weighing competing alternatives and then making choices. While
outside consultants can certainly provide valuable assistance in the process,
top management must take the lead. Instead of just reviewing and approving a
nice binder of initiatives prepared by the consultant, they need to be highly
engaged in a process of debate followed by decision making.
When the focus is on the process, not just the output, it’s easier to make it an
ongoing effort. That’s because managers develop a deeper understanding of and
buy into the analysis and options that were considered in developing the
strategic plan. As active participants in its development, they also have a
greater sense of ownership, and thus much more willingness to keep it up to
date.
Define and track
Don’t view strategic planning as simply setting long-range goals. A good plan
also includes strategies (broad directions to achieve your goals) and programs
(shorter term actions required to implement the strategies).
For example, to achieve a goal of doubling market share, you may devise a
strategy to open or acquire three new locations over the next three years.
Programs will consist of the actions to be undertaken each year to build or buy
the new stores.
But your strategic plan won’t go anywhere unless it contains a set of metrics,
such as incremental market share improvement, and milestones, such as opening
the third store on the assigned date, to measure the plan’s implementation
progress. Accountability is also key. Assign responsible individuals to oversee
each goal, strategy or program. And regularly assess their progress against the
metrics and milestones.
Update when needed, not when scheduled
Some businesses make annual updates to their strategic plans, whether they’re
needed or not. That’s certainly better than letting the plan sit on the shelf,
but it’s not sufficient.
When investigating why so many businesses didn’t use their strategic planning
process to drive major business decisions, researchers from Marakon Associates
and the Economist Intelligence Unit found that the need to make these decisions
didn’t always coincide with the annual planning calendar. Rather, an
opportunity to buy out a competitor, the loss of key employees, a technological
breakthrough, or major disruptions to suppliers or customers created a need to
update the plan.
Discipline, not chaos
Effective strategic planning is difficult. It requires a discipline that many
organizations fail to achieve, leaving them directionless and reactive rather
than focused and able to create their own opportunities. Businesses that can
master the art of strategic planning as an ongoing process stand a good chance
of meeting — or exceeding — their long-range goals.
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Gain a clearer picture of your profitability with ABC
If questioned about profitability, some business owners
would answer based on their gut feelings; others would
extrapolate information from their financial accounting
systems. To more accurately assess your business’s
profitability, match costs with the activity that drives
them. Activity-based costing (ABC) helps you do just that.
The problem with traditional cost accounting
Traditional cost accounting, also known as managerial
accounting, divides costs into direct (such as the labor and
materials that go into a product or service) and indirect or
overhead costs (such as facilities, equipment, utilities,
human resources, marketing and customer service). The
indirect costs are allocated according to certain direct
costs, typically direct labor. So, if product A accounts for
65% of all direct labor expense and product B accounts for
35%, indirect costs will be allocated in the same
proportion.
The problem with this approach is that many indirect costs
don’t correlate to direct labor expense. For instance, the
amount of marketing, customer service, or even amortization
of equipment for Product B may greatly exceed that for
Product A, even though A’s labor costs are more expensive.
This wouldn’t be a problem if overhead were only a small
portion of total costs, but, in many businesses today, just
the opposite is true. So, using the traditional approach may
produce less than accurate information.
The ABCs of ABC
ABC works very differently, because it takes a
multidimensional approach. With ABC, a hierarchy of
activities is established, and significant factors that
contribute to an activity’s cost — called cost drivers — are
identified at each level. Some activities will be at the
individual product level, such as packaging materials.
Others, such as product design, could be at the product line
level, while transportation costs can be attached to an
order. Yet another set of activities — human resources,
information systems, customer service and management — may
be at the overall company level.
These cost drivers will vary by activity. In a factory, for
example, indirect costs may be driven by the square footage
needed, equipment setup and maintenance requirements, and
energy consumed. For a wholesaler, shipping costs might be
driven by the size of the order, the weight of the order and
the mode of transportation.
Using ABC methodology, specific activities — no matter where
they occur in the hierarchy — may be linked to a specific
product or service and added to the direct labor and
material costs of the item.
Using ABC to your advantage
Implementing ABC doesn’t have to be a major undertaking, but
it does require a changed mindset. Why? ABC often tests
conventional wisdom and creates a situation that challenges
the business to make difficult decisions regarding products
and customers.
For example, if ABC shows that Products 1 and 2 are
profitable, but Product 3 is losing money, management must
decide what to do about Product 3 to improve its status. ABC
will help the company analyze which activities are adding
costs to Product 3 that could be reduced or eliminated and
then decide whether it’s best to raise the price of Product
3 or even discontinue the product altogether. The same is
true for evaluating customer profitability.
Should you be learning your ABCs?
While ABC grew out of manufacturing, its use is now much
more widespread. Retailers, distributors, health care
organizations and many other service providers have
benefited from using ABC. If your company isn’t getting the
type of information it needs to properly evaluate its
profitability, you may want to consider ABC.
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Production numbers
Understanding the manufacturers’ deduction
In 2004, the American Jobs Creation Act (AJCA) added the
manufacturers’ deduction (also known as the Section 199
deduction) to the tax code, creating a new tax break for
domestic production activities. But this deduction isn’t
just for manufacturers. Construction firms, engineers,
architects, software developers, agricultural processors and
other types of businesses may also benefit.
Computing this deduction is complicated and, until recently,
there were many questions left unanswered. Fortunately, the
IRS has provided interim guidance on applying the deduction
and issued final regulations on the subject.
What is it?
The manufacturers’ deduction permits eligible taxpayers to
deduct a specified percentage of their income from
“qualified production activities” or their taxable income
for the year, whichever is lower. The deduction is also
limited to 50% of certain W-2 wages a taxpayer pays during
the year.
The applicable percentage is 3% this year, increasing to 6%
for 2007 and 9% for 2010. Once the deduction is fully phased
in, its impact will be to lower the top effective marginal
tax rate on qualifying income from 35% to 32%.
How does it work?
Qualified income is calculated by taking gross receipts from
qualified domestic production activities (domestic
production gross receipts, or DPGR) and subtracting the
costs of goods sold and certain other direct and indirect
costs allocable to those activities. Gross receipts qualify
for the deduction if they’re derived from any lease, rental,
license, sale, exchange or other disposition of:
• Qualifying production property (including tangible
personal property, computer software and certain sound
recordings) manufactured, produced, grown or extracted by
the taxpayer in whole or in significant part within the
United States,
• Qualified films produced by the taxpayer,
• Construction, engineering or architectural services
performed in the United States for domestic construction
projects, or
• Electricity, natural gas or potable water produced by the
taxpayer in the United States.
Two exceptions are receipts from the sale of food and
beverages prepared by the taxpayer at a retail establishment
and the transmission or distribution of electricity, natural
gas or potable water.
Which gross receipts qualify?
To determine whether gross receipts qualify, you must
analyze them item by item. If a unit of property fails to
qualify — because, for example, it’s not produced in
significant part within this country — it may be possible to
define an item as a component of the property that meets the
requirements. Let’s suppose that you manufacture leather and
rubber shoe soles in the United States, import shoe uppers
and manufacture shoes for sale by attaching the soles to the
imported uppers. If the shoes fail to meet the
manufacturers’ deduction requirements but the soles do, you
must treat the soles as the item for purposes of the
deduction.
Also, under a de minimis exception, if nonqualified property
accounts for 5% or less of your gross receipts, you may
treat all of your receipts as DPGR.
What does “in significant part” mean?
To qualify for the deduction, property must be manufactured,
produced, grown or extracted “in significant part” within
the United States. Generally, this test is met if, based on
all the facts and circumstances, the activities the taxpayer
performs in this country are “substantial in nature.”
The regulations also provide a safe harbor: A taxpayer meets
the in-significant-part test if its U.S. labor and overhead
costs related to the property constitute at least 20% of the
property’s cost of goods sold. The final regulations also
provide guidance for leases, license agreements and other
transactions in which “cost of goods sold” doesn’t apply.
How are costs allocated?
The tax code and regulations provide detailed rules for
allocating costs of goods sold and certain deductions,
expenses and losses between DPGR and non-DPGR. The final
manufacturers’ deduction regulations allow you to use a
simplified deduction method if you have average annual gross
receipts of $100 million or less or total assets of $10
million or less. Under the simplified method, you can
allocate costs and other items based on the percentage of
your total receipts that qualify as DPGR.
Is more guidance expected?
These are just a few examples of the issues addressed by the
recent final regulations. Guidance is also provided on the
treatment of software, calculation of the W-2 wage and
taxable income limitations, computation of the deduction by
pass-through entities, and more.
The final regulations left a number of unanswered questions.
The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA)
modified the allocation of wages to partners and
shareholders of pass-through entities for purposes of
calculating the manufacturers’ deduction. The IRS will
provide additional guidance on these issues in the near
future.
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Tax Tips
Using powers of appointment to avoid GST taxes
The generation-skipping transfer (GST) tax is a flat tax at
the highest marginal estate tax rate (currently 46%) on
gifts or bequests to grandchildren or others who are two or
more generations below you. The GST tax exemption currently
shields up to $2 million from GST taxes; it increases to
$3.5 million in 2009.
But if you expect to exceed the exemption, you may be able
to avoid GST taxes by giving your children general powers of
appointment that allow them to direct your property to their
children. Although this strategy causes the property to be
included in your children’s estates, the GST tax savings
almost always will outweigh any estate tax liability that
may result.
Why you might want to convert your IRA
High-income taxpayers who were prevented from converting to
a Roth IRA because of income limits received a gift from
Congress earlier this year. The Tax Increase Prevention and
Reconciliation Act (TIPRA) eliminated the $100,000 adjusted
gross income ceiling for Roth IRA conversions. There’s one
catch: You can’t take advantage of this opportunity until
2010.
There are a number of advantages to conversion: Roth IRA
earnings are tax free, even though contributions aren’t
deductible. Plus, unlike traditional IRAs, a Roth IRA isn’t
required to make minimum distributions starting at age
701⁄2. Conversion of a traditional IRA into a Roth IRA is
considered a taxable distribution, but it’s not subject to
the 10% penalty on early withdrawals. If you convert your
IRA in 2010, you can elect to spread the income over a
two-year period. •
Save the environment and taxes, too
The conservation easement is an often-overlooked estate
planning tool that allows you to save taxes now while
preserving the beauty and utility of land and structures for
future generations. By giving up certain rights to develop
property, you reduce its market value.
The tax benefits are now greater than before. Under the
Pension Protection Act of 2006, the deduction for the value
of the easement, subject to certain limits, has increased
from 30% to 50% through 2007. You may also be entitled to
state income tax deductions or credits.
Because a conservation easement reduces the property’s
market value, it also lowers estate taxes. In addition, the
donor may exclude up to 40% of the land’s value from his or
her estate with a maximum exclusion of $500,000.
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