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USTaxAdvising
USTaxAdvising, CPA
Category: Tax
Satisfied Customers: 1237
Experience:  US Taxation specialist.
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I'm looking to buy a spa business that my wife has worked in

Customer Question

I'm looking to buy a spa business that my wife has worked in for 6 years. However, the balance sheet shows a negative retained earnings of nearly $100K. They have been in business since 2004 and have gross receipts of about $212K last year, on pace for the same this year. My question is does the debit in the RE indicate trouble or just the owners creative accounting skills? Thank you.
Submitted: 1 year ago.
Category: Tax
Expert:  USTaxAdvising replied 1 year ago.

Hello,

A deficit in retained earnings would lead one to believe that the company is not profitable. Having said that one would need to determine the method of accounting used for the books and records. Are the books are records prepared under US GAAP accounting principles or on an Income Tax Basis?

If the books are on an Income Tax Basis there may be large "non cash" deductions such as depreciation and amortization expense. These expenses would help to drive the deficit in retained earnings.

I would recommend looking deeper into the accounting and be skeptical. A deficit in retained earnings does indicate the company is not profitable. One would have to evaluate the cash flow statement as well to see if it is using up more cash from operations than it has coming in. If you see "cash inflow from financing activities" then I would be led to believe the owners are putting money in to keep the business running.

I hope this helps. Please let me know if you have any follow up questions on this and I will get back to you as soon as I can.

Best regards,

Customer: replied 1 year ago.
I see they have a $140K depreciation on the books, that would point to the Income Tax Basis booking?
Expert:  USTaxAdvising replied 1 year ago.

Hello - yes that would be indicative but depreciation is also booked for US GAAP/accounting purposes and is generally much slower than for US tax purposes. For US tax purposes depreciation is generally accelerated and deducted much faster than US GAAP allows. If you can look at the tax returns the depreciation deducted on the financials should agree to the depreciation deducted on the tax returns. If it does not then I would expect the number on the tax returns to be higher.

Best,