A common complaint I hear, mostly from business owners, is they are "paying too much tax".
Most employees get it. They receive the net wages from their employer, and only get a tax deduction when they’ve spent their cash money to do their job.
Some business owners on the other hand, think every time they are paying the ATO, they are paying tax. And they are - it's just not theirs.
So let’s set the record straight.
You don’t have a tax problem.
You have a cash flow problem.
As a business owner GST is not your money. PAYG Withholding is not your money (and I’ll add, superannuation – which no-one thinks is tax, but is also not your money).
The only tax that is yours, is income tax.
If you’re on the PAYG Instalment system that will be only one component of the BAS amount you pay each quarter. And then you balance up when you do your tax return to either get a refund if your quarterly instalments were too much or pay the difference if your quarterly instalments were too little.
So the problem, generally, isn’t that you are paying too much tax, it’s that your spending the cash to pay for it, on something else. Like your personal life, like stock, or more fixed assets (i.e cars, machinery, equipment).
A simple cash flow test
If you couldn’t pay your PAYG withholding and superannuation each pay run to your employees in their pay packet – you are essentially using their money (borrowing in another form) to fund your business and lifestyle.
PAYGW and Super is their money, you’re just transferring it to a different bank account for them.
If you can’t pay the GST on each BAS – you are using the money of the federal government – which granted people aren’t too worried about doing.
But if you can’t pay the GST each BAS, then you’ve spent the cash on something else.
It’s very rarely the case that there is an enormous on-going error and you’re paying twice as much GST, PAYGW or income tax than you need to. And if you are, sack your accountant and get a new one.
Yes, tax accountants (like us) can help you minimise taxes, but realistically the best they are going to do is shave off a few grand here and there.
The only big tax savings come when there is a change in your affairs – like retirement, selling a business, or one of your kids turning 18 etc.
These types of events (changes) provide opportunities to do some serious tax planning. But if you’re in the thick of running a business, and you’ve used some (essentially set and forget) tax strategies then tax is what it is until something in your affairs changes.
So it’s highly unlikely that your tax bill is going to zero, or even halve. And if it does, whilst your profit is still the same – I’d be getting that checked out – either your accountant has stuffed up the historical lodgements, or the current one.
What can you do about cash flow problems?
If you believe what I’ve written above, and accepted the fact that your tax is within a few grand of being optimal, and you’re struggling to pay the bills, what can you do?
Do a cash flow Forecast
I know, I know, every accountant ever born tells you this. And there is a good reason we all tell you this BECAUSE ITS IMPORTANT AND PEOPLE STILL DON'T DO IT!
Having a cash flow forecast isn't about being dollar perfect. It's about showing you the ins and outs of your cash and when they will occur.
It's like going fishing. You check the time of the tides before you launch the tinny right? You're not too worried that low tide today is 1.2m and tomorrow it will be 1.4m. It's still low tide so you can't launch. So you wait until high tide right?
This is the same as your cash flow forecast. If you know that December and January is low tide for cash flow, then don't run off and buy a new car in the end of year sales, or get all excited about the year ahead and put on 3 extra staff. You can't launch a bigger boat in the same low tide. You need the tide to rise. And in business that when it's time to talk to your bank or finance broker (who'll probably ask for a cash flow forecast. Ha!) and pitch how with the lender's help your business is going to go bananas and they'll get their money back.
Look at your financial statements
The Profit and loss statement has sales at the top, expenses below that, left over is profit or loss. Nice.
But are those expenses reasonable?
Do you need them all to run your business?
And if you do, are you paying a fair price?
The big ticket ones are always, cost of materials, wages, and rent. Then, depending on the business is things like advertising and marketing (if you’re trying to grow or in e-commerce this can be WAY MORE than your other expenses) – is it working? Are you making profit on the sale once you factor in your cost of customer acquisition? Then insurance, then increasingly software subscriptions etc etc..
So go through each of these expense lines and work out whether they are a) necessary and b) you’re getting value for money.
Once you’ve done that – it’s time to look at where you spent your profit (or funded your loss). You’ll know from experience, that profit doesn’t equate to the amount in your bank account. So where did it go?
Your balance sheet.
Now whilst that is 100% true, it’s also kind of glib.
There is a line on your balance sheet that says “current year earnings”. But that doesn't tell you anything much. It's not representative of what you did with it and the only reason it's there is thanks to the double entry accounting system.
Now I’m not going to give you a lecture on that and how it works but I will tell you, that your current year profit has been spent on the MOVEMENT in your balance sheet.
So it’s not the cash balance at 30 June 2021, it’s the movement between the cash balance between 30 June 2020 and 30 June 2021.
It’s not the amount of fixed assets at 30 June 2021, it’s the movement between 30 June 2020 and 30 June 2021.
Every asset that has increased you have invested profit into. Every liability that has increased, you’ve borrowed from.
Every asset that has decreased has increased your cash flow. Every liability that has decreased, you’ve spent cash on (decreased cash flow).
Now that was a quick overview of your source and application of funds which really needs it’s own article/video so I’ll leave it there. But my point is, if you’ve gone out and increased your equipment or stock, or your debtors have blown out or the clearing account with The Iconic has doubled over last year – that’s where a large chunk of your cash flow has gone.
Likewise, if you’ve smashed down your debt since this time last year, or paid back all those suppliers, then that is where more of your cash has gone. And it is reasons like this, that you don’t have the cash to pay the BAS, or super or your tax bill on your tax return and that's why you need a cash flow forecast!
You Might Also Like
Tax Is Just A Cost of Doing Business
Yes, income tax is a big expense in business. But it’s a necessary cost of doing business and should be examined as much as you examine your other expenses. If you do the quick sums and get your gross tax and divide by your sales, you’ll see that it is a fairly low percentage of your sales. Here let me show you;
Cost of Goods Sold
Net Profit (before tax)
Income Tax (25%)
Tax/sales = $25,000/$1,000,000 = 2.5%
Know your Numbers
Every accountant also tells you this - so maybe it's time to listen up. Knowing numbers is more than just knowing your sales for the year, or your profit number. It's knowing your margins, and how much of each sale is being spent on advertising, wages, rent and tax. It's knowing your break even point, and cash flow high and low points.
By doing just those 3 things you should understand where your cash is going, which should allow you to make a plan to improve things. If your in a loss position, borrowing money to pay bills you already have isn’t going to fix the fundamental issue that you are losing money.
Borrowing to increase sales, might be the answer – but only if it results in sufficient gross profit on each sale to not only fund the direct costs, and existing overheads – but also make the repayments on the new debt! Again, this is why you need a cash flow forecast.
If you’re in a profit position and have no cash, then you need to understand where the cash is going.
If the balance sheet account “Directors Loan” is ever growing – that’s one area to address. If it’s going into stock, that’s another. And by knowing where the profit is being spent, you can find the right funding mechanism for your business, which will then allow you to pay your completely average amount of tax.