Net worth normally consists of your initial and maybe subsequent capital investments in your dealership. This is shown, based on what type of taxable entity you are, as either common stock, paid in capital, partner’s capital or sole proprietor’s capital.
Additional paid in capital consists of amounts contributed to capital in excess of the stated value of the number of shares of stock you have purchased from the company. This can vary from state to state. Treasury stock, which is not very common, can also be a part of your net worth, normally decreasing it for stock that was redeemed by the company itself from former stockholders.
Net income adds to your net worth and a net loss decreases your net worth. The cumulative net income and losses incurred since your company’s inception are accumulated in retained earnings for a C or S corporation. If you are not a corporation, it is normally accumulated and added to your capital account along with your initial investment. It can be left in a separate capital account if you prefer to review it on your internal financial statements. However, for tax return purposes and CPA prepared and issued financial statements it is netted together on the balance sheet with your capital account.
The last component can be either dividends or distributions. A C corporation can pay out dividends (corporations only) and an S corporation can pay out either dividends and/or distributions. This is the amount of cash or other assets you have withdrawn from dealership income generated in the current year or prior years. These dividends or distributions are normally limited to the amount of income generated in the current or prior years for federal income tax purposes if you are a C or S corporation. If you are a sole proprietorship, single member LLC or a partnership, then distributions can exceed the amount of cumulative income generated under federal tax law. There are certain limitations that should be discussed with your tax accountant each year so you know the amount you have left to distribute without incurring “phantom” income and possible income tax.
If your net worth is not changing, it may be the result of losses, net income decreased by dividends or distributions, or a combination of both. If you have a good year and post $300,000 of net income, but distribute it out to yourself you won’t see an increase. If this is the case, then I hope you are investing it in other profitable investments that will help you retain the income and net worth you’ve generated over the years. If you are spending your net worth and have nothing to show for it, you need to ask yourself, “Why?” How will you ever enjoy retirement if you are spending all of your profits now?
Additionally, without an increase in net worth you will not have additional capital available to invest in dealership growth or to fund years in which your business experiences a loss. It is also likely that your financial institution will be unhappy with their amount of risk due to your management style. Banks want you to have a substantial investment in your business so you are at risk as much or more than they are.
Your personal and business net worth should be increasing each year, thus building equity and cash flow or long-term investments. If you do take money out of your company, you should be increasing your personal net worth by approximately the same amount. The only thing that would not increase your net worth would be distributions made to you for payment of your federal and state income taxes on the income of your business.
Now that you know what the components of net worth are, take a good look at your own dealership and affiliated companies. Chart your net worth changes month by month for the prior year and year-end by year-end for at least five years. If you can’t find your year-end financial statements, and you are a corporation or partnership, you can get these amounts from your annual federal income tax return which has a balance sheet section or page.
By carefully and diligently monitoring your net worth you can understand and focus on increasing your net worth. Once you have evaluated where you really are, talk to your tax adviser to find out if you should be structuring your net worth to minimize any long-term tax effects with estate planning or different company tax structures. You won’t get there if you don’t start planning now. What are you waiting for?
Vol 4, Issue 3