Sauder & Stoltzfus Blog

Preface: Optimizing vendor costs, or purchases, is an opportunity to increase profits for any business. Astute negotiating with vendors can often lead to an increase in gross profit and net income percentages. Consider yourself a good negotiator? Is that D10T the better deal in a box? Let’s say it practical.

Vendor Management and Negotiation

What would your business do without good vendors? Maintaining supportive affinity with vendors is vital to a successful business; albeit a top priority. Vendor terms, discounts and payment negotiations, can reduce your cost of goods sold and increase net income with a little extra effort; the greater your cost of goods sold, the more value your business can obtain from optimal vendor negotiations. For instance, if your cost of goods sold is $870,000, a savings of 2% on vendor terms is $17,400. If cost of goods sold is 60% of sales on $1,450,000, for either the month or the year, then your net income increases 1.2% from good cash management using vendor discounts. If cost of goods sold are say $2,500,000, a 2% cost reduction is $50,000. It’s easy to see, negotiating vendor terms can be as important as advertising to increase revenue.

Vendors are people, just like your customers. You should learn the names of those in the accounting department who send invoices and process payments. Who has key decision making authority at the vendors to negotiate discounts? Treat your vendors the same way you want your customers to treat you. If cash is restricted, tell your vendors, be proactive in communicating late payments; a good vendor will have stringent terms on payment, but most often understand if you communicate honestly the situation. Yet, if you can pay something towards the balance, it is always advisable to do so.

Before you begin negotiating vendor terms, research thoroughly the company and acquaint yourself with the products the vendor supplies. You may be aware that the vendor supplies stroopwafels, but do you know what other products they merchandise. One discipline, to manage vendor costs, is to research the vendor website and any marketing documents to gain an increased knowledge of their target market. Will your business be .05% of their yearly revenue or 5%?  Review competitor’s prices and payment policies to obtain industry options. If you want a line of stroopwafels for inventory, it may be more convenient to purchase from a distributor who can negotiate volume discounts than from the stroopwafel boutique. Yet, price is not always the key factor. If you are purchasing circuit boards, your due diligence is significantly more important. Price may be one component, but supply channel bandwidth, lag times, and quality, with an optimal in-the-field success rate may be more important. If you are purchasing commodities such as 2×8 lumber or propane fuels, vendor discounts can be valuable, significantly valuable. Don’t over negotiate, but put in the effort to get good deals.

Negotiating must include incentives. If you have your research in hand, you will know what incentive you can offer. Negotiating options include: (I) Referring new business, if you have contacts that you can refer to the vendor you have value to leverage, (II) Volume guarantees, if you can guarantee you will order $150,000 a year, a vendor may consider a valuable discount opportunity in entirety, (III) ACH or credit payment access, if the vendor has the comfort of having access directly to your checking account, and payment is certain, you add value to the relationship. Avoid being abrasive or negotiating vendor terms without an incentive plan in place; but combine new business referrals, volume guarantees, credit payment access, and additional values, and you gain stellar negotiating strength that can increase your revenue profitability.

Preface: Amortization of intangible assets is similar yet different than depreciation. It is governed by a different Section of the IRC and methods are unique to the intangible asset based on the IRC code section relevant to various intangible. This blog is provide an explanation of amortization and namely IRC Code Section 197 relevant to the majority of small business intangible assets.

Amortization of a Businesses Intangible Assets

Amortization is the expensing of intangible asset costs ratably over the intangible assets life. Amortization is governed with Internal Revenue Code (IRC); including section 197 and 195. Section 197 assets have a three factor test 1. They must be listed in Section 197 descriptions, 2. They must have been purchased, 3. They must be held in connection with the conduct of trade of business or investment activity. Factor 1 assets in Code Section 197 include: goodwill, workforce in place, patents, copyrights, formulas, processes, designs, patterns, market share, customer lists, licenses, permits, governmental rights, covenants not to compete, franchise fees, trademarks, trade names, contracts for use of acquired intangibles, and information bases in a business. This is not a comprehensive list of Section 197 assets, but the majority of the typical Section 197 intangibles.

Intangibles in Section 197 are expenses ratably over 15 years, beginning with the month of the acquisition. In businesses where intangibles are purchases along with other business assets, the intangible assets are determined by subtracting the cost of Class 1, Class 2 and Class 3 assets from the purchase price. This information is listed on IRS Form 8594 Asset Acquisition Statement.  For example, if a business is purchases $150,000 of intangible assets, including goodwill and patents in a acquisition, the intangible costs would be expensed at say $10,000 for 15 years, and not depreciated at standard MACRS methods of say 7 years at say a 200% declining balance.

Other assets are also amortized that are not in IRC Section 197. These include interests in partnerships, corporations, trusts, and estates, interests in land, computer software, and professional fees incurred in corporate organizations or reorganizations, accounts receivable, and interest in a lease of tangible property, etc.

Start-up expenses can be amortized with IRC Section 195. Code Section 195 expenses require that the expense must be for investigating the creation or acquisition of an active trade or business; for creating an active trade or business, activities engaged in for profit and for production of income before the day business begins, the taxpayer must elect to amortize the start-up expense.

Amortization rules have a few nuances, including amortization of intangible drilling and development expenses of oil or gas wells over a sixty month period under IRC Section 59; IRC Section 171(a) (2) permits the amortization of bond premiums, and disallowed amortizations such as the elections to amortize expenses paid or incurred in creating or acquiring musical compositions or copyrights to compositions is no longer a permissible tax feature in tax years beginning after 2010. Amortization of lease fees can be amortized for the lifespan of the lease too, and not a set amortization span.

Summarized: Amortization expenses differ from depreciation, in the fact that they are in intangible assets vs. tangible assets. Intangible is key here. Typically amortization is on the straight-line expensing method and not MACRS methods applicable to tangible property. When amortizing assets, talk with your CPA for appropriate handling of the intangible.