What Is a SIMPLE IRA?

Q: What Is a Simple IRA?

The SIMPLE IRA, or Saving Incentive Match Plan for Employees, is a type of tax advantaged retirement savings plans to help self-employed savers and small business owners put money away for their future.

Q: How Does a SIMPLE IRA Work?

In order for an employee to participate, including self-employed individuals, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, or they must expect to make $5,000 in the current calendar year. It is possible for employers to set less restrictive rules for SIMPLE IRA eligibility.

Oct

2024

The Ultimate Guide to SIMPLE IRAs for Employees and Small Businesses

By Austin Kilham | Growing Wealth, invest, Investing | Comments Off

SIMPLE IRA is a tax-advantaged retirement account that can help self-employed individuals and small business owners save and invest for the future.

You may already be familiar with traditional individual retirement accounts (IRAs). A SIMPLE IRA, or Saving Incentive Match Plan for Employees, is similar to a traditional IRA in that it’s also a tax-deferred account. But the contribution limits for SIMPLE IRAs are higher, and the tax treatment of these plans is slightly different.

Also, SIMPLE IRAs require employers to provide a matching contribution.

What Is a SIMPLE IRA?

SIMPLE IRA plans are employer-sponsored retirement accounts for businesses with 100 or fewer employees. They are also retirement accounts for the self-employed and sole proprietors. If you’re your own boss, and thus self-employed, you can set up a SIMPLE IRA for yourself.

For small business owners and the self-employed, SIMPLE IRAs are an easy-to-manage, low-cost way to contribute to their own retirement — while at the same time helping employees to contribute to their savings as well, both through tax-deferred, elective contributions, and a required employer match.

SIMPLE IRAs offer higher contribution limits than traditional IRAs (see below), but employers and employees still benefit from tax advantages like tax-deferred growth and contributions that are either deductible (for the employer) or reduce taxable income (for the employee).

How Does a SIMPLE IRA Work?

A SIMPLE IRA is one of many different types of retirement plans available, but it can be appealing for small business owners and those who are self-employed owing to the lower administrative burden.

That’s because, unlike a 401(k) plan (which requires a plan sponsor and a plan administrator, as well as a custodian for employee assets), a SIMPLE IRA basically enables the employer to set up IRA accounts at a financial institution for eligible employees — or allow employees to do so at the financial institution of their choice.

Once the plan is set up and contributions are made, the employee is fully vested (i.e., they have ownership of all SIMPLE IRA funds, per IRS rules), which is helpful when saving for retirement.

Employee Eligibility

In order for an employee to participate in a SIMPLE IRA, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, and they must expect to make $5,000 in the current calendar year.

It’s possible for employers to set less restrictive rules for SIMPLE IRA eligibility. For example, they could lower the amount employees are required to have made in a previous two-year time. However, they cannot make participation rules more restrictive.

Employers can exclude certain types of employees from the plan, including union members who have already bargained for retirement benefits and nonresident aliens who don’t receive their compensation from the employer.

Employee Contribution Limits

Those who have a SIMPLE IRA can contribute up to $16,000 in 2024 (plus an extra $3,500 in catch-up contributions for those 50 and older).

Contributions reduce employees’ taxable income, which lowers their income taxes in the year they contribute. Contributions can be invested inside the account, and may grow tax-deferred until an employee makes withdrawals when they retire.

IRA withdrawal rules are particularly important to pay attention to as they can be a bit complicated. Withdrawals made after age 59 ½ are subject to income tax. If you make withdrawals before then, you may be subject to an additional 10%, with some exceptions, or 25% penalty (if you’ve had the account for less than two years).

Account holders must make required minimum distributions, or RMDs, from their accounts when they reach age 72 (or age 73, if you turn 72 after Dec. 31, 2022).

Matching Contributions

An employer is required to provide a matching contribution to employees in one of two ways. They can match up to 3% of employees’ compensation. Or they can make a non-elective contribution of 2% of employees’ compensation.

If an employee doesn’t participate in the SIMPLE IRA plan, they would still receive an employer contribution of 2% of their compensation, up to the annual compensation limit, which is $345,000 for 2024.

This two-tiered structure allows employers to choose whatever matching structure suits them.

💡 Quick Tip: Want to lower your taxable income? Start saving for retirement with a traditional IRA. The money you save each year is tax deductible (and you don’t owe any taxes until you withdraw the funds, usually in retirement).

¹Terms and conditions apply. Roll over a minimum of $20K to receive the 1% match offer. Matches on contributions are made up to the annual limits.

SIMPLE IRA vs Traditional IRA

When it comes to a SIMPLE IRA vs. a traditional IRA, the two plans are similar, but there are some key differences between the two. A SIMPLE IRA is for small business owners and their employees. A traditional IRA is for anyone with earned income.

To be eligible for a SIMPLE IRA, an employee generally must have earned at least $5,000 in compensation over the course of two years prior — and expect to make $5,000 in the current calendar year. With a traditional IRA, an individual must have earned income in the past year.

Contribution Limits

One of the biggest differences between the two plans is the contribution limit amount.

While individuals can contribute $7,000 in 2024 to a traditional IRA (or $8,000 if they are 50 or older), those who have a SIMPLE IRA can contribute $16,000 in 2024, plus an extra $3,500 in catch-up contributions for those 50 and older, for a total of $19,500.

Tax Treatment

And while both types of IRAs are considered tax deferred, SIMPLE IRAs use two different tax treatments.
For example: a traditional IRA generally allows individuals to make tax-deductible contributions. With a SIMPLE IRA, the employer or sole proprietor can make tax-deductible contributions to a SIMPLE IRA — while employees benefit from having their elective contributions withheld from their taxable income.

Both methods can help lower taxable income, potentially providing a tax benefit. But withdrawals are taxed as income, as they are with a traditional IRA.

SIMPLE IRA vs 401(k)

SIMPLE IRAs have some similarity to employer-sponsored 401(k) plans. Contributions made to both are made with pre-tax dollars, and the money in the accounts grows tax-deferred.

But while a 401(k) gives an employer the option of providing matching contributions to employees’ plans, a SIMPLE IRA requires matching contributions by the employer, as noted above.

Another major difference between the two plans is that individuals can contribute much more to a 401(k) than they can to a SIMPLE IRA.

• In 2024, they can contribute 23,000 to their 401(k) and an additional $7,500 if they’re 50 or older.

• In comparison, individuals can contribute $16,000 to a SIMPLE IRA, plus an additional $3,500 if they are 50 or older.

How to Run a SIMPLE IRA Plan

SIMPLE IRAs are relatively easy to put in place, since they have no filing requirements for employers. Employers cannot offer another retirement plan in addition to offering a SIMPLE IRA.

If you’re interested in setting up a SIMPLE IRA, banks and brokerages may have a plan, known as a prototype plan, that’s already been approved by the IRS.

Otherwise you’ll need to fill out one of two forms to set up your plan:

• Form 5304-SIMPLE allows employees to choose the financial institutions that will receive their SIMPLE IRA contributions.

• You can also fill out Form 5305-SIMPLE, which means employees will deposit SIMPLE IRA contributions at a single financial institution chosen by the employer.

Once you have established the SIMPLE IRA, an account must be set up by or for each employee, and employers and employees can start to make contributions.

Notice Requirements for Employees

There are minimal paperwork requirements for a SIMPLE IRA. Once the employer opens and establishes the plan through a financial institution, they need to notify employees about it. This should be done by October 1 of the year the plan is intended to begin. Employees have 60 days to make their elections.

Eligible employees need to be notified about the plan annually. Any changes or new terms to the plan must be disclosed. At the beginning of each annual election period, employers must notify their employees of the following:

• Opportunities to make or change salary reductions.

• The ability to choose a financial institution to receive SIMPLE IRA contribution, if applicable.

• Employer’s decisions to make nonelective or matching contributions.

• A summary description provided by the financial institution that acts as trustee of SIMPLE IRA fund, and notice that employees can transfer their balance without cost of penalty if the employer is using a designated financial institution.

Participant Loans and Withdrawals

Participants cannot take loans from a SIMPLE IRA. Withdrawals made before age 59 ½ are typically subject to a 10% penalty, or 25% if the account is less than two years old, in addition to any income tax due on the withdrawal amount.

Rollovers and Transfers to Other Retirement Accounts

For the first two years of participating in a SIMPLE IRA, participants can only do a tax-free rollover to another SIMPLE IRA. After two years, they may be able to roll over their SIMPLE IRA to a traditional IRA or an employer-sponsored plan such as 401(k).

A rollover to a Roth IRA would require paying taxes on any untaxed contributions and earnings in the accounts.

💡 Quick Tip: Before opening an investment account, know your investment objectives, time horizon, and risk tolerance. These fundamentals will help keep your strategy on track and with the aim of meeting your goals.

The Advantages and Drawbacks of a SIMPLE IRA Plan

While SIMPLE IRAs may offer a lot of benefits, including immediate tax benefits, tax-deferred growth, and employer contributions, there are some drawbacks. For example, SIMPLE IRAs don’t allow employees to save as much as other retirement plans such as 401(k)s and Simplified Employee Pension (SEP) IRAs.

In 2024, employees can contribute up to $23,000 to a 401(k), plus an additional $7,500 for those 50 and over.
Individuals with a SEP IRA account can contribute up to 25% of their employee compensation, or $69,000, whichever is less, in 2024.

The good news is, employees with SIMPLE IRAs can make up some of that lost ground. Employers may be wondering about the merits of choosing between a SIMPLE and traditional IRA, but they can actually have both.

Employers and employees can open a traditional or Roth IRA and fund it simultaneously with a SIMPLE IRA. For 2024, total IRA contributions can be up to $7,000, or $8,000 for those 50 and over.

Here some pros and cons of starting and funding a SIMPLE IRA at a glance:

Pros of a SIMPLE IRA	Cons of a SIMPLE IRA
Employers are required to provide a matching contribution for all eligible employees.	Lower contribution limits than other plans, such as 401(k)s and SEP IRAs.
Lower cost and less paperwork than other retirement accounts; there are no filing requirements with the IRS.	Withdrawals made before age 59 ½ are subject to a possible 10% or 25% penalty, depending on how long the account has been open.
Contributions are tax deductible for employers and pre-tax for employees (both lower taxable income).	Participants cannot take out a loan from a SIMPLE IRA.
A SIMPLE IRA may offer more investment options than a 401(k) or other employer plan.	There is no Roth option to allow employees to fund a SIMPLE account with after-tax dollars that would translate to tax-free withdrawals in retirement.

Eligibility and Participation in a SIMPLE IRA

As mentioned previously, there are some rules about who can participate in a SIMPLE IRA. Here’s a quick recap.

Who Can Establish and Participate in a SIMPLE IRA?

Small business owners with fewer than 100 employees and self-employed individuals can set up and participate in a SIMPLE IRA, along with any eligible employees.

Employers can’t offer any other type of employer-sponsored plan if they set up a SIMPLE IRA.

Employees’ Eligibility and Participation Criteria

In order for an employee to be eligible to participate, they must have earned at least $5,000 in compensation over the course of any two years prior to the current calendar year, and they must expect to make $5,000 in the current calendar year.

Employees can choose less restrictive requirements if they choose. They may also exclude certain individuals from a SIMPLE IRA, such as those in unions who receive benefits through the union.

Investment Choices and Account Maintenance

Because the employer doesn’t have to set up investment options for the SIMPLE IRA, employees have the advantage of setting up a portfolio from the investments available at the financial institution that holds the SIMPLE IRA.

Investment Choices for a SIMPLE IRA

Typically, there may be more investment choices with a SIMPLE IRA than there with a 401(k) because the SIMPLE IRA account may be held at a financial institution with a wide array of options.

Investment choices can include stocks, bonds, mutual funds, exchange-traded funds (ETFs), target-date funds, and more.

Understanding SIMPLE IRA Distributions

There are particular rules for SIMPLE IRA distributions, as there are with all types of retirement accounts.

Withdrawal Rules and Tax Consequences

As discussed previously, withdrawals made before age 59 ½ are subject to income tax plus a potential 10% or 25% penalty, depending on how long the account has been open.

Withdrawals made after age 59 ½ are subject to income tax only and no penalty. Account holders must make required minimum distributions from their accounts when they reach age 72, or 73 if you turn 72 after Dec. 31, 2022.

The 2-Year Rule and Early Withdrawal Penalties

There is a two-year rule for withdrawals from a SIMPLE IRA. If you make a withdrawal within the first two years of participating in the plan, the penalty may be increased from 10% to 25%, with some exceptions (e.g., for a first-time home purchase, for higher education expenses, and more). In addition, all withdrawals are subject to ordinary income tax.

The Takeaway

SIMPLE IRAs are one of the easiest ways that self-employed individuals and small business owners can help themselves and their employees save for retirement, whether they’re experienced retirement investors or they’re opening their first IRA.

These accounts can even be used in conjunction with certain other retirement accounts and investment accounts to help individuals save even more.

Ready to invest for your retirement? It’s easy to get started when you open a traditional or Roth IRA with SoFi. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).

Help grow your nest egg with a SoFi IRA.

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SOIN-Q324-054

Oct

2024

Guide to EBITDAR: What You Should Know

By Lauren Ward | SMB | Comments Off

EBITDAR, which stands for earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs, is an operational efficiency metric. It’s often used by investors, lenders, and business owners to understand how well a company is performing from its primary business operations. It does this by adding back non-operational, non-recurring, and non-cash expenses to net income.

Here’s what you need to know about EBITDAR, including how to calculate it, how it’s used, and what it can tell you about your business.

Key Points

• EBITDAR measures a company’s operating performance by excluding interest, taxes, depreciation, amortization, and rent expenses.

• It’s commonly used in industries with significant rent costs, like hospitality and airlines, to compare companies more accurately.

• EBITDAR helps assess a company’s profitability before non-operational costs and financial obligations.

• Pros of EBITDAR include showing a company’s operating cash flow and allowing investors to compare companies with different non-cash, non-recurring, and non-operating expenses.

• Cons of EBITDAR include it’s not regulated by GAAP and the numbers can be easily manipulated.

What Is EBITDAR?

EBITDAR is a variation of EBITDA (earnings before interest, taxes, depreciation, and amortization), an accounting method that removes the effects of non-operational costs from net income. The only difference? EBITDAR also excludes restructuring and rental costs. (EBITDAR is also similar to adjusted EBITDA, which includes the removal of various one-time, irregular, and non-recurring items from EBITDA.)

By removing rental costs, investors can analyze companies that may have similar operations but that choose to access assets differently — some companies rent while others choose to own. Excluding rentals allows comparison of profits apples-to-apples.

EBITDAR is also an important measure if you are exploring business loans because it is often used by lenders to estimate the cash flows that a company has available for principal and interest payments.

Breakdown of EBITDAR

Here’s a breakdown of each part of EBITDAR and why each variable is important.

Earnings: Earnings are the profit a business makes off of its core operations. With EBITDAR, earnings are calculated by subtracting expenses from total revenue. However, unlike net earnings, EBITDAR doesn’t subtract all business expenses. It factors in the cost of goods sold, general and administrative expenses, and other operating expenses, but doesn’t subtract costs that are not directly related to the company’s operations, namely interest paid on debt, amortization and depreciation expenses, income taxes, and the cost of restructuring or renting.

Interest: The interest a company pays on its loans is added back to net income with EBITDAR. The reasoning behind this is that while interest is an expense, it doesn’t reflect how well the company is utilizing its debt. Businesses take on different amounts of debt for different reasons and receive different interest rates based on a variety of factors (for example, credit score, existing debt, and collateral).

Taxes: Each locality has different tax laws. Depending on where a business is located, it may have a dramatically different tax burden than another company with the same amount in sales. To better compare companies, EBITDAR removes the effect of taxes on net income. This makes it easier to compare the performance of two or more companies operating in different states, cities, or counties.

Depreciation: Depreciation is the process of writing off the cost of a tangible asset over the course of its useful life. With EBITDAR, depreciation is added back to net income because depreciation depends on past investments the business has made and not on the company’s operating performance.

Amortization: Amortization is similar to depreciation, but is used to spread out the cost of intangible assets, such as patents, copyrights, trademarks, non-compete agreements, and software. These assets also have a limited useful life due to expiration. Amortization is added back to net income in EBITDAR because this expense isn’t directly related to a business’s core operations.

Restructuring costs: The restructuring of land or a building is an expense that doesn’t occur very often for most companies. And, many analysts view it as more of an investment that could potentially help the company generate additional revenue and profits. As a result, any costs associated with restructuring are added back to net income with EBITDAR to give analysts a better understanding of how well the central business model is performing.

Rental costs: Because rent can vary significantly from one location to the next and is not within a business’s control, rent costs are added back to net income in EBITDAR. This allows for a better understanding of a company’s operating performance and potential. In addition, rent is a sunk cost, which means the expense is guaranteed to occur regardless of how a company performs.

Recommended: Partnership Business Loans Explained

EBITDAR Formula

The standard formula for EBITDAR is:

EBITDAR = Net income + Interest + Taxes + Depreciation + Amortization + Restructuring or Rent Costs

An alternative formula:

EBITDAR = EBITDA + Restructuring/Rental Costs

where:

EBITDA = Earnings before interest, taxes, depreciation, and amortization

Recommended: Debt-to-EBITDA Ratio Explained

How Does EBITDAR Work?

The premise of EBITDAR is that certain expenses can distract analysts from understanding how well a company is bringing in business. It only includes core operating expenses, and the following expenses are added back to net income:

• Non-cash expenses

• Non-recurring expenses

• Non-operational expenses

What EBITDAR Tells You

EBITDAR, rather than EBITDA (earnings before interest, taxes, depreciation, and amortization), is primarily used to analyze the financial health and performance of companies that have gone through restructuring within the past year or have unique rent costs, such as restaurants, casinos, shipping companies, and airlines.

EBITDAR (like EBITDA) is also useful for measuring a company’s operating cash flow and for comparing the profitability of companies with different capital structures and in different tax brackets.

However, companies do have to pay interest, taxes, and rent, and must also account for depreciation and amortization. As a result, EBITDAR does not paint a complete picture or offer a true measure of how profitable a business is. In some cases, it can be used to hide poor choices. A company could use this metric to avoid showing things like high-interest loans or aging equipment that will be costly to replace.

Recommended: What is EBIDA?

When to Use EBITDAR

EBITDAR is commonly used when evaluating businesses in industries with significant rent or lease costs, such as hospitality, retail, or airlines. It provides a clearer view of operational performance by excluding expenses like interest, taxes, depreciation, amortization, and rent.

This metric is particularly useful for comparing companies with different lease or property ownership structures, as it standardizes performance across various financial arrangements. Investors and analysts rely on EBITDAR to assess profitability before accounting for non-operational costs, helping them understand the core earnings potential of a company, especially in rent-heavy sectors.

Example of EBITDAR

Here is the income statement for Company X for 2024:

Revenue	$800,000
COGS	$150,000
Gross Profit	$650,000
Operating expenses:
Rent	$5,000
Depreciation	$25,000
Amortization	$15,000
Marketing	$5,000
Administrative	$5,000
Total Operating Expenses:	$55,000
Interest	$20,000
Taxes	$120,000
Net Income:	$455,000

To use Company X’s income statement to arrive at EBITDAR, you would add back interest ($20,000), taxes ($120,000), depreciation ($25,000), amortization ($15,000), and rent ($5,000) to arrive at an EBITDAR of $640,000 for 2024.

Pros and Cons of Using EBITDAR

Pros of Using EBITDAR	Cons of Using EBITDAR
Helps analysts zero-in on a company’s operational efficiency and performance	Taxes, interest, depreciation, amortization, and restructuring/rental costs are still expenses that affect a company’s cash flow
Enables analysts to compare companies with different non-cash, non-recurring, and non-operating costs	Not regulated by GAAP
Show a company’s operating cash flow	There are many ways for companies to manipulate their EBITDAR numbers to mislead investors

Recommended: What Is GAAP and How Does It Work?

EBITDAR vs EBITDA

EBITDAR and EBITDA are both metrics used to measure a company’s operational performance. The key difference is that EBITDAR also excludes rent costs, making it particularly useful for industries with high lease expenses, like retail or hospitality.

EBITDA, on the other hand, focuses on core earnings without factoring in non-operational costs like depreciation and interest. While both metrics assess profitability, EBITDAR offers a more specific view in rent-heavy businesses, whereas EBITDA is more widely applicable.

EBITDAR vs EBIT

EBIT (earnings before interest and taxes) and EBITDAR are both metrics used to evaluate a company’s operational performance. EBIT focuses on core earnings by excluding interest and tax expenses, making it a key measure of profitability. EBITDAR takes this a step further by also excluding depreciation, amortization, and rent, providing a clearer view of a company’s operational performance in rent-heavy industries like hospitality or retail.

While EBIT is widely applicable, EBITDAR is particularly useful for comparing businesses with significant lease obligations.

EBITDAR vs Net Income

EBITDAR and net income are both profitability metrics, but they measure different aspects of a company’s performance. EBITDAR focuses on operational earnings by excluding key expenses like interest, taxes, rent, depreciation, and amortization, offering insight into core operations.

Net income, on the other hand, is the company’s total profit after all expenses, including non-operational costs like interest, taxes, and depreciation, are deducted. While EBITDAR helps assess operational efficiency, net income reflects overall profitability and is more comprehensive for understanding a company’s financial health.

The Takeaway

EBITDAR, or earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs, is a valuation metric of a firm’s profitability without considering the tax rate and the capital structure of the company. It aims to measure a company’s profitability from its core operations.

While similar to EBITDA, EBITDAR goes a step further by removing the effects of rent or restructuring costs. This makes it a better tool for companies that have non-recurring or highly variable rent or restructuring costs, such as casinos and restaurants.

Calculating EBITDAR can be helpful for seeing how your business performs from one quarter or year to the next, as well as how it compares to other businesses in your industry. It may also come into play if you’re applying for a business loan. Banks and other lenders often look at EBITDAR (or EBITDA) when deciding whether your business is a risk they’re willing to take on.

If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

What is the difference between EBITDAR and EBITDA?

EBITDAR (earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs) and EBITDA (earnings before interest, taxes, depreciation, and amortization) are very similar metrics. The only difference is that with EBITDAR, restructuring or rental costs are also added back to net income.

Is EBITDAR the same thing as gross profit?

No. Gross profit is calculated by subtracting the cost of goods sold (COGS) from revenue. Unlike EBITDAR (earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs), gross profit does not include non-production costs.

What is the formula for calculating EBITDAR?

To calculate EBITDAR (earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs), you add certain non-recurring, non-operating, and non-cash expenses back to net income. The formula is: Net income + Interest + Taxes + Depreciation + Amortization + Restructuring/ Rental Costs = EBITDAR.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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SOSMB-Q324-048

Oct

2024

GAAP: Generally Accepted Accounting Principles

By Lauren Ward | SMB | Comments Off

GAAP, an acronym for generally accepted accounting principles, is a set of rules and principles that public companies in the U.S. must follow when preparing their annual financial statements.

Without GAAP, it would be much more difficult for lenders, investors, and other interested parties to know how a business is performing.

Read on to learn more on what GAAP is, how it works, pros and cons of GAAP, the differences between GAAP and non-GAAP, and more.

Key Points

• GAAP stands for generally accepted accounting principles.

• It provides a common set of accounting standards, ensuring consistency in financial reporting.

• GAAP enhances the clarity and transparency of financial statements for investors and stakeholders.

• It ensures that financial data is reported accurately, reducing the risk of errors or fraudulent reporting.

• GAAP has 10 fundamental principles that companies must follow.

What Is GAAP?

GAAP, or generally accepted accounting principles, is a commonly recognized set of rules and procedures designed to govern corporate accounting and financial reporting in the U.S.

GAAP was established to provide consistency in how financial statements are created, eliminate the potential for fraudulent or misleading financial reports, and make it easier for investors and creditors to evaluate companies and compare them apples-to-apples.

All publicly traded businesses in the U.S. must use GAAP in their financial statements. While small businesses that don’t get audited aren’t required to use GAAP, doing so can still be helpful, particularly if your business may be interested in attracting an investor or exploring small business loans at some point.

How GAAP Works

• FAF oversees the FASB and GASB organizations

• FASB issues GAAP rules for businesses and nonprofits

• GASB issues GAAP standards for state and local governments

For businesses filing periodic reports with the U.S. Securities and Exchange Commission (SEC), GAAP dictates how a company can recognize revenue and expenses and how information needs to be presented to shareholders in an audited report. It also standardizes the financial reporting process so that third parties can easily compare and contrast two GAAP-compliant companies or entities.

GAAP incorporates three components to help eliminate misleading accounting and financial reporting practices:

• 10 accounting principles

• Rules and standards issued by the FASB or GASB

• Generally accepted industry practices

Why Is GAAP Important?

GAAP is crucial because it provides a standardized framework for financial reporting, ensuring consistency, accuracy, and transparency across businesses. This allows investors, regulators, and stakeholders to compare financial statements and make informed decisions. GAAP also helps maintain trust in the financial system by reducing the risk of fraud and misrepresentation.

Recommended: Guide to EBITDAR: What You Should Know

Pros and Cons of GAAP

GAAP offers a number of benefits. It guides companies in preparing accurate and clear financial data, reduces fraudulent financial reporting, and provides consistency in the financial statements of one GAAP-compliant company to another.

However, GAAP also has some limitations. Its “one-size-fits-all” approach to financial reporting, for example, doesn’t always address issues faced by specific industries. GAAP can also be overly complex, as well as costly to implement, for smaller businesses. And, it’s not a globally used standard, which can make it challenging for international organizations and for investors who want to compare companies operating in different countries.

Pros of GAAP

Here are some of the pros of GAAP:

• Fosters honesty and transparency in financial reporting

• Makes it easy to compare one GAAP-compliant company to another GAAP-compliant company

• Ensures that businesses follow the same accounting principles for all reporting periods

• Enables businesses to compare their performance with that of their competitors

Cons of GAAP

Here are some of the cons of GAAP:

• Strict accounting model does not address many industry-specific situations

• Can be costly for smaller companies to become GAAP-compliant

• Overshadows non-U.S. GAAP financial performance metrics, such as adjusted EBITDA

• Not a global standard

10 Important GAAP Principles

GAAP has 10 fundamental principles companies must follow:

1. Principle of Regularity

Accountants must adhere to the rules and regulations of GAAP accounting. This principle keeps accountants from making up their own methods. With GAAP, any accountant can understand the work of another accountant. This is extremely important when comparing businesses and analyzing their worth.

2. Principle of Consistency

Accountants must apply the same standards and techniques for all accounting periods. This ensures financial comparability between periods. Any changes or updated standards must be explained in the footnotes to the financial statements.

3. Principle of Sincerity

Accountants must be as honest, impartial, and accurate in their reporting of a company’s financial performance as possible. They cannot lie or fudge numbers to make a company seem more profitable.

4. Principle of Permanence of Methods

All GAAP-compliant companies must be consistent with their methods and procedures. By doing so, all GAAP-compliant companies can be compared regardless of their industry.

5. Principle of Non-Compensation

Businesses must report all aspects of their performance, both good and bad, and without the expectation of debt compensation.

6. Principle of Prudence

Accountants should never speculate or give their opinion in a financial report. All records must only include expenses and provisions for spending that have or will certainly take place.

7. Principle of Continuity

While valuing assets, accountants must assume the business will continue to operate in the foreseeable future. Any potential buyouts or foreclosures should not be considered.

8. Principle of Periodicity

Accountants must report all revenue and expenses in the appropriate accounting period, such as fiscal quarters or fiscal years.

9. Principle of Materiality

Accountants must strive to fully disclose all financial data and accounting information in financial reports.

10. Principle of Utmost Good Faith

All parties that contribute to a company’s financial report are assumed to be honest and reputable.

Recommended: Debt-to-EBITDA Ratio Explained

Alternatives to GAAP

IFRS

The International Financial Reporting Standards, or IFRS, are another set of accounting standards, but these are used at the international level. IFRS is standard in the European Union and many countries in Asia and South America, but not in the United States. IFRS was established so that companies could be comparable from country to country.

The main difference between GAAP vs. IFRS is that GAAP prioritizes rules and detailed guidelines, whereas IFRS only provides general principles to follow. Accountants have more leeway when following IFRS, but often need to include explanatory documents. On the other hand, businesses that use GAAP may feel confined by the lengthy rules.

Recommended: How to Calculate Cash Flow

Tax-Basis Accounting

Tax-basis accounting follows the accounting that a company is required to use for filing its federal tax return. If allowed by creditors, investors, and other financial statement users, tax-basis accounting can make sense for a privately held company, since it means less work when preparing the company’s tax return. When comparing tax-basis vs. GAAP accounting, tax-basis accounting is less complex and often leads to less footnote disclosures in financial statements.

GAAS

Generally accepted auditing standards, or GAAS, is the framework that guides auditors. GAAS standards help auditors prepare a transparent and reliable audit report on companies. Following these standards also ensures that auditors don’t miss any important information. When comparing them, it’s important to remember that GAAP is used by accountants, whereas GAAS is used by auditors. Therefore, an auditor following GAAS may see how well a company is following GAAP.

Recommended: Explaining GAAS vs GAAP

The Takeaway

GAAP is the set of accounting rules and principles that public U.S. companies must follow when putting together financial statements. The goal of GAAP is to hold publicly traded companies accountable and ensure their financial statements are complete, consistent, and comparable.

For small business accounting, you are not required to follow GAAP regulations. However, doing so can make it easier for outsiders to evaluate your business and compare it with other companies in your industry. Publishing GAAP-compliant financial statements could make it easier for your business to attract an investor or get approved for certain types of business loans.

With SoFi’s marketplace, it’s fast and easy to search for your small business financing options.

FAQ

How many principles does GAAP have?

The generally accepted accounting principles, or GAAP, has ten principles. They are:

1. Principle of regularity

2. Principle of consistency

3. Principle of sincerity

4. Principle of permanence of methods

5. Principle of non-compensation

6. Principle of prudence

7. Principle of continuity

8. Principle of periodicity

9. Principle of materiality

10. Principle of utmost good faith

Is GAAP the same in every country?

No, only U.S. publicly traded companies must use GAAP (generally accepted accounting principles). IFRS (International Financial Reporting Standards) is used in the European Union and many countries in Asia and South America.

Why is GAAP important?

GAAP (generally accepted accounting principles) is important because it ensures honesty, transparency, and uniformity in financial reporting. Without GAAP standards, businesses could report their earnings differently, which could make it difficult for investors and creditors to evaluate and compare companies, and could also provide opportunities for fraud.

What does GAAP stand for?

GAAP is the acronym for generally accepted accounting principles, a comprehensive framework of accounting rules. GAAP is primarily used in corporate accounting and financial reporting in the United States.

Who oversees GAAP?

Three nonprofit organizations — the Financial Accounting Foundation (FAF), Financial Accounting Standards Board (FASB), and Governmental Accounting Standards Board (GASB) — play a role in setting GAAP standards. FAF oversees the FASB and GASB organizations, while FASB issues GAAP rules for businesses and nonprofits and GASB issues GAAP standards for state and local governments. The U.S. Securities and Exchange Commission (SEC) can establish GAAP via government regulations, but it typically allows the private sector to establish the standards.

Photo credit: iStock/AndreyPopov

SOSMB-Q324-047

Oct

2024

What Is a Golden Cross Pattern in Stocks? How Do They Form?

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Editor's Note: Options are not suitable for all investors. Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Please see the Characteristics and Risks of Standardized Options.

The golden cross pattern is a technical indicator that appears when a security’s short-term moving average rises above its long-term moving average. A golden cross is generally interpreted as the sign of an upcoming market rally.

The golden cross pattern is a momentum indicator, and it tends to be popular because it is easy for chart watchers to spot and interpret. It doesn’t occur as often as other chart patterns, but when it does it sometimes even makes news headlines because it is a strong bullish indicator for a stock or an index.

How Do Golden Cross Patterns Form?

The golden cross candlestick chart pattern happens when the short-term moving average (e.g. the 50-day moving average) moves above and crosses a long-term moving average such as the 200-day moving average, or DMA.

It is an indicator that the market will probably head in a bullish direction, and can be used by stock investors, day traders, swing traders, options traders, or anyone interested in analyzing price movements.

A moving average is a graph of the average value of a stock price for some trailing period of time. Commonly used moving averages are the 50-day moving average (DMA) as a short-term measure and the 200 DMA as a long-term measure.

That said, traders can use moving averages of various lengths, from hours to months, to capture a desired time frame.

Recommmended: Important Candlestick Patterns to Know

3 Stages of a Golden Cross

There are three stages that form the Golden Cross pattern:

1. Downtrend. The first stage of the golden cross happens before the moving average lines cross. A downtrend occurs, and the short-term average is lower than the long-term average, but then buyer volume starts exceeding seller volume.

2. Breakout. Next, the cross happens. The short-term moving average crosses over and above the long-term moving average, reflecting a reversal of the downward trend and upward momentum.

3. Upward momentum. The trend continues and the prices continue to rise, with both the short- and long-term DMAs creating support levels (the lower end of both average prices) and indicating movement toward a bullish market.

Understanding support and resistance levels is key to reading technical charts. Support indicates where the price tends to stop falling; resistance indicates where the price tends to stop rising.

What Does a Golden Cross Tell Traders?

When the short-term average is higher than the long-term average, this means that short-term prices are rising compared to previous prices, showing bullish momentum.

The candlestick pattern that’s opposite the golden cross is the Death Cross chart pattern, which is when the short-term average moves below the long-term average, indicating a bearish market trend.

You can think of the golden cross pattern as a logical example of how price momentum can work. Because it’s the short-term DMA that rises and crosses the long-term DMA in a stock chart, it makes sense that analysts would interpret this as a bullish indicator that could have some staying power, as the short-term DMA would eventually play into the long-term DMA.

How Does a Golden Cross Work?

A golden cross occurs in a technical chart when the short-term moving average dips down to its resistance level, and then moves upward, crossing the long-term moving average.

Traders can use different time periods when conducting technical analysis, but the use of the 50-day moving average and the 200-day moving average are common when it comes to identifying the golden cross pattern. The longer the time period, the more lasting the upward trend may be.

Different traders, for example day traders or options traders, can use shorter periods, depending on when they’re aiming to place trades and what their strategy is.

Pros and Cons of Using the Golden Cross

The golden cross can be a useful technical pattern for traders to use to spot changes in market trends. However, on its own it has some limitations.

Benefits of the Golden Cross

The golden cross is known as one of the strongest bullish technical indicators, and can reflect other positive underlying factors in a particular stock.

Furthermore, since the pattern is so widely known, it can attract buyers, thereby helping to fulfill its own prediction.

Drawbacks of the Golden Cross

Like any chart pattern, there is no guarantee that prices will rise following the golden chart pattern.

Chiefly, the golden cross is a lagging indicator. It shows historical prices, which are not necessarily an indicator of future price trends.

Even if prices do rise, they might not rise for long after the golden cross forms.

Due to these uncertainties, it is best to use the golden cross in conjunction with other indicators.

How to Trade a Golden Cross

Both long-term and short-term traders can use the golden cross to help them decide when to enter or exit trades. It can be used both for individual stocks and for trading market indexes.

Most traders use the golden cross and Death Cross along with other indicators and fundamental analysis, such as the relative strength index (RSI) and moving average convergence divergence (MACD).

RSI and MACD are popular indicators because they are leading indicators, potentially providing more real-time information than the golden cross pattern.

What Time Frame Is Best for a Golden Cross?

The most popular moving averages to use to spot the golden cross are the 50-DMA and the 200-DMA. However, day traders may also spot the golden cross using moving averages of just a few hours or even one hour.

Whatever the chosen time period, traders enter into the trade when the short-term average crosses over the long-term, and they exit when the price reverses again.

Because the golden cross is a lagging indicator, investors enter a trade when the stock price itself rises above the 200-DMA rather than waiting for the 50-DMA to cross over the 200-DMA. The logic being: If traders wait for the pattern to form they may have missed the best opportunity to enter into the market.

Short sellers may also use the golden cross to determine when the market is turning bullish, which is a good time for them to exit their short positions.

The Takeaway

Chart patterns are useful tools for both beginning investors and experienced traders to spot market trends and find entry and exit points for trades. The golden cross is one indicator that technical analysts might use to determine whether a stock or market is bullish.

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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Options involve risks, including substantial risk of loss and the possibility an investor may lose the entire amount invested in a short period of time. Before an investor begins trading options they should familiarize themselves with the Characteristics and Risks of Standardized Options . Tax considerations with options transactions are unique, investors should consult with their tax advisor to understand the impact to their taxes.
Disclaimer: The projections or other information regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOIN0124098

Oct

2024

What Is Escrow & How Does It Work?

By Jody McMaster | Home Ownership, mortgage | Comments Off

Escrow isn’t the most euphonious word, but it’s important when you’re a homebuyer and homeowner. In real estate transactions, escrow is the process of keeping money in trust until certain conditions are met. There are a couple different ways that escrow might be used, so let’s look more closely at this important process.

Key Points

• Escrow involves a neutral third party holding money and documents during the home sale process to ensure both parties meet agreed terms.

• During home buying, the buyer’s earnest money is held in escrow until the sale is finalized.

• Post-purchase, escrow accounts help mortgage lenders ensure timely payment of property taxes and insurance.

• Escrow protects buyers, sellers, and lenders.

• Escrow costs typically range from 1% to 2% of the home’s sale price, varying by location.

What Is Escrow?

There are a couple of ways that escrow is used. The first time you might encounter it is during the home-buying process, when your good-faith deposit (also known as “earnest money”) is held in escrow until the sale is finalized.

The funds are kept in the care of an escrow agent, who ensures that the deal terms are met by both sides. This protects both the buyer and the seller during the homebuying journey, which can sometimes be bumpy.

After you purchase a home, an escrow account is often used again as a way to help the mortgage lender ensure that an owner pays property taxes and home insurance fees in a timely and consistent fashion (more on that later). In this scenario, your mortgage loan payments will include taxes and insurance. An escrow account set up by the lender or mortgage servicer will accrue that portion of your monthly payment and pay the tax and insurance bills when they’re due.

First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.

When you make an offer on a home and the seller accepts it, you’ll typically submit some earnest money. This good-faith deposit shows the seller that you are serious about buying the property. Once the seller accepts your offer, the buyer’s or seller’s agent opens an escrow account with an escrow provider, often a title company. The earnest money, as well as the purchase agreement, the seller’s deed, and other documents are held there in escrow until the sale is final.

The earnest money deposit (typically 1% to 3% of the purchase price, though it can be more in a hot market) is verified by the escrow agent, and evidence is sent to the lender in writing.

Buyers who minimize contingencies in their purchase agreement risk forfeiting their earnest money deposit.

Common contingencies include the mortgage contingency, which allows either party to walk away from the deal if the buyers are unable to secure financing by the agreed-upon deadline, and the sale of current home contingency, when buyers need the proceeds from the sale of their existing home to afford the new home.

Others are appraisal and home inspection contingencies. These will all be written into the purchase contract.

As the process moves forward, the escrow agent is responsible for ordering a title search, and tracking and verifying the items laid out in the escrow instructions for the home sale.

The earnest money deposit is held in escrow and when the sale goes through it is used toward the down payment and closing costs.

Sometimes, funds are held in escrow beyond the closing. When this happens, it’s called an escrow holdback. It might occur if, for example, you and the seller make an arrangement that allows the seller to stay in the house for a month after the closing. Money would be held in escrow to pay the seller’s final utility bills. Or perhaps the seller has agreed to make a repair to the home but the work is not completed at the time of closing. Funds might be held in escrow to cover the cost until the repair is made.

What’s the Benefit of Escrow?

Escrow is designed to protect the buyer, seller, and lender until the transaction is complete. Having a neutral third party handle the paperwork and transfer of funds can benefit all parties in a real estate sale.

Escrow is required when you obtain financing, but it is used in cash sales as well. As a buyer, it can be comforting to know that all the transaction details are being handled by the appropriate parties.

As a seller, escrow provides a safeguard if anything goes wrong with the sale. For example, if the borrower backs out of the sale and breaks terms of the contract, the earnest money deposit may be forfeited by the buyer.

Recommended: Selling a House With a Mortgage

How Much Does Escrow Cost?

Escrow companies usually charge a base fee plus a percentage of the purchase price. That typically comes to 1% to 2% of a home’s sale price, but the cost varies by state and county.

For a $400,000 house, an escrow charge of 2% would be $8,000.

You may want to ask your real estate agent or mortgage lender to recommend a title company with low rates.

In many states, the buyer and seller split escrow fees or negotiate how they will be divided. The market temperature — buyer’s or seller’s market — can affect the negotiation.

Escrow After the Sale of the House

If you put less than 20% down on a conventional loan or take out a government-backed loan, your lender will typically establish an escrow account at closing where you will place money to pay homeowner’s insurance, property taxes, and, if necessary, private mortgage insurance (commonly called PMI). If your home is required to have flood insurance, then your lender is, in turn, required to escrow your insurance fees for this policy.

Once established, the account is maintained by monthly contributions that you make as part of your mortgage payment. When taxes and insurance are due, the lender or servicer pays them.

The escrow amount will be reflected on your mortgage statements. Once a year, your lender or loan servicer will examine your escrow account to make sure it is collecting the proper amount to cover your property taxes and insurance, and adjust your monthly payment as necessary.

If an excess of more than $50 is anticipated, you’ll receive an escrow refund. If the excess is less than $50, the loan servicer can choose whether to send you a refund or apply the overage to the following year. In the event of an escrow shortage, the homeowner might be asked to make an extra payment to escrow (this happens, for example, if there is an unexpected increase in property taxes). A loan servicer may also allow the homeowner to make up the shortage by adding to their monthly payments going forward. Either way, the monthly payment will be adjusted to ensure that, going forward, it reflects the true cost of the year’s taxes and insurance bills.

Using an escrow account for taxes and insurance helps protect you and your lender by ensuring that you maintain proper insurance coverage and pay your taxes on time. Consider what could happen if a property owner allows home insurance to lapse and then the home is damaged or destroyed: There would be no insurance funds to pay to repair or rebuild the home, and both the owner and lender would take a loss financially.

Recommended: What Is PMI and How to Avoid It

The Takeaway

What is escrow in real estate? It’s the holding of money and documents by an impartial third party during a home sale, or the lender’s collection of funds from a mortgage holder so that the lender can ensure that insurance fees and taxes are paid. Escrow is intended to protect buyer, seller, and lender and should bring peace of mind to all involved in a real estate transaction or mortgage.

Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.

SoFi Mortgages: simple, smart, and so affordable.

FAQ

What is an escrow balance?

The escrow balance is the money that is held in a mortgagor’s escrow account to pay taxes, insurance, and if applicable, private mortgage insurance and flood insurance.

What is an escrow agreement?

An escrow agreement is a contract that outlines the terms and conditions of a transaction for something of value, which a third party holds until all conditions have been met.

What does it mean to be in escrow?

It means that an escrow agent is holding the earnest money, loan funds, and property deed until an appraisal and title search are done and financing has been approved. The earnest money typically will be applied to the down payment or closing costs as the closing progresses.

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*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

This article is not intended to be legal advice. Please consult an attorney for advice.

SOHL-Q324-114

The Ultimate Guide to SIMPLE IRAs for Employees and Small Businesses

What Is a SIMPLE IRA?

How Does a SIMPLE IRA Work?

Employee Eligibility

Employee Contribution Limits

Matching Contributions

Get a 1% IRA match on rollovers and contributions.

Double down on your retirement goals with a 1% match on every dollar you roll over and contribute to a SoFi IRA.1

SIMPLE IRA vs Traditional IRA

Contribution Limits

Tax Treatment

SIMPLE IRA vs 401(k)

How to Run a SIMPLE IRA Plan

Notice Requirements for Employees

Participant Loans and Withdrawals

Rollovers and Transfers to Other Retirement Accounts

The Advantages and Drawbacks of a SIMPLE IRA Plan

Eligibility and Participation in a SIMPLE IRA

Who Can Establish and Participate in a SIMPLE IRA?

Employees’ Eligibility and Participation Criteria

Investment Choices and Account Maintenance

Investment Choices for a SIMPLE IRA

Understanding SIMPLE IRA Distributions

Withdrawal Rules and Tax Consequences

The 2-Year Rule and Early Withdrawal Penalties

The Takeaway

Guide to EBITDAR: What You Should Know

What Is EBITDAR?

Breakdown of EBITDAR

EBITDAR Formula

How Does EBITDAR Work?

What EBITDAR Tells You

When to Use EBITDAR

Example of EBITDAR

Pros and Cons of Using EBITDAR

EBITDAR vs EBITDA

EBITDAR vs EBIT

EBITDAR vs Net Income

The Takeaway

FAQ

What is the difference between EBITDAR and EBITDA?

Is EBITDAR the same thing as gross profit?

What is the formula for calculating EBITDAR?

GAAP: Generally Accepted Accounting Principles

What Is GAAP?

How GAAP Works

Why Is GAAP Important?

Pros and Cons of GAAP

Pros of GAAP

Cons of GAAP

10 Important GAAP Principles

1. Principle of Regularity

2. Principle of Consistency

3. Principle of Sincerity

4. Principle of Permanence of Methods

5. Principle of Non-Compensation

6. Principle of Prudence

7. Principle of Continuity

8. Principle of Periodicity

9. Principle of Materiality

10. Principle of Utmost Good Faith

Alternatives to GAAP

IFRS

Tax-Basis Accounting

GAAS

The Takeaway

FAQ

How many principles does GAAP have?

Is GAAP the same in every country?

Why is GAAP important?

What does GAAP stand for?

Who oversees GAAP?

What Is a Golden Cross Pattern in Stocks? How Do They Form?

How Do Golden Cross Patterns Form?

3 Stages of a Golden Cross

What Does a Golden Cross Tell Traders?

How Does a Golden Cross Work?

Pros and Cons of Using the Golden Cross

Benefits of the Golden Cross

Drawbacks of the Golden Cross

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