Understanding Financial Statements and Business Organizations
Q: Why would Fresno Properties not have any cash?
A: That is a very good question with no obvious answer. Some companies, however, tend to zero out their cash balances at the end of the year by providing distributions or loans to owners. Driving cash balances down to zero seems extreme, but a company would only do so if it were assured of a continuous flow of cash receipts, which is the case for Fresno Properties. Fresno Properties receives rental payments continuously throughout the year, with the majority bunched around the beginning of the month. So a zero cash balance at December 31 may be transformed to a substantial cash balance two weeks later.
Q: How do you determine whether a distribution from an LLC is a tax-free distribution vs. a distribution of the taxable share of profits?
A: A distribution is a deduction from the profits remaining in the business. Whether the amount of the distributions was just for income tax payment is another issue. An LLC may not claim a member's salary as a tax-deductible expense. Therefore, distributions are the common vehicle for providing members with the cash they need to pay their tax obligation on the LLC''s taxable income, as well as cash for compensation.
For example, if the member's effective personal income tax rate is 20%, then any amount of distributions that exceeds 20% of the LLC's taxable income is compensation for the member.
Please keep in mind that distributions received by members of an LLC are not reported as taxable income on the members’ Form 1040. Distributions are tax-free cash income to the member. Distributions can be taxable to the member only if they exceed the member's "basis" in the LLC, which is roughly his or her initial investment increased by his or her share of profit retained in the company over time. If distributions exceed a member's "basis", the amount in excess of the “basis” is taxed as a long-term capital gain.
Q Are preliminary site costs similar to a down payment?
A: Preliminary site costs are not the equivalent of a down payment. In this case, preliminary site costs represent the cost of property surveys, plot layouts, soil tests, grading, etc. that are necessary in preparing the site for subsequent construction.
Preliminary site costs are an asset to the company, essentially long-term work in process. Just as work in progress is recorded as an asset along with raw materials on a manufacturing company’s balance sheet, preliminary site costs are recorded as an asset on a developer’s balance sheet. This asset represents expenses incurred to prepare a site for development, such as fees paid to survey teams and engineers. All preliminary site costs go into the final cost and value of an income producing property that is then used to produce revenue or sold.
Course overview: Understanding Financial Statements and Business Organizations