Managing your Tax Obligations whilst growing your business

We've heard it many times, there are two certainties in life - death and taxes. Everybody has to pay Tax. For employees they hardly have to worry about it as largely it is cared for through the PAYE deductions from their salary/wages but for the self-employed, paying taxes can potentially destroy your business unless you learn to manage it.

So here are a couple of tips on how to manage your tax payments and at the same time successfully grow your business.

The key point...

The key point is to plan for your taxes from Day 1 of your business. Normally your business will make a profit and so you need to make a plan as to how you are going to pay your taxes. Get your Accountant to prepare a cash-flow forecast and financial plan to help you establish how much tax you are likely to have to pay over the next 12 months. Then you need to monitor the actual results against the budgeted results and from this you can accurately increase or decrease the tax payments you need to make throughout the year.

The common 'three provisional payments' method...

Most self-employed will pay their Income Tax through their three Provisional Tax payments throughout the year. (Business people who operate through a Company can put themselves on the company payroll and pay themselves a PAYE deducted salary/wage. This is like paying your tax monthly and it is a great way to keep on top of your tax obligations.)

However we often find that with the hustle and bustle of everyday business and having slow debtors paying you and having to buy more stock and new assets etc, small businesses struggle with the three provisional tax payments they have to pay each year.

Alternative ways to pay...

We suggest you take the total amount and break it into either monthly or weekly APs which are sent directly to the IRD. So take a business that needs to pay $9,000 of Income Tax per year. All the IRD requires is 3 payments of $3,000 during the year. However this can be a major stumbling block to small business owners to save up for the 3 lump sums especially if you have a slow period or have slow payers paying you. So take the $9,000 and if you want to pay monthly then it works out to be $750 per month. Or if you want to pay weekly take the $9,000 and it works out to be $175 per week. These are far easier amounts to pay rather than large amounts 3 times a year.

Another way to save up for your tax payments is to have a Tax Savings Account and set yourself to put money into the account on a regular basis. However these Tax Savings Accounts only work if you are an extremely disciplined person. The danger of savings accounts are that they can be raided for ‘other’ things like buying new fixed assets or paying for the owner’s holiday etc., etc. They are OK if you are an extremely disciplined person but the temptation to use the money for something else often trips up many business owners and when it’s time to pay your tax, the Tax Savings Account is empty!

Be aware of where your cash is going

Remember if you have tax to pay it means you’re making a profit (and that’s a good thing)! If you don’t have any money to pay your tax you need to understand where your profit is going to. Mostly the profit gets taken by owner’s drawings, purchasing of fixed assets, repayment of debt or the increase of stock and/or debtors

Let’s look at those four things mentioned in the last paragraph in more detail.

Be very careful how much you as the owner take from the business for yourself as drawings. It’s very tempting to spend up large when the business bank account is looking healthy. However, this can be fatal your business. The best way for business owners to regulate their personal spending is to pay a fixed amount each week into their personal bank account which is their ‘wages’ and they live off that amount. This then allows the business bank account to grow and have money to pay for their Income Tax obligations etc.

When you pay cash for a new fixed asset (i.e. you don’t use borrowed money to purchase the asset) you must remember that the money you are using is pure profit that you have generated. So if you spend $10,000 on a new asset then you are using up $10,000 of your ‘cash profit’. What people forget is that you actually have to pay tax on that $10,000 of profit. So, say the tax on that $10,000 is $3,000, when your tax time comes around you have to find that $3,000 from somewhere else in your cash-flow. This is a common problem amongst small businesses that they spend a lot of money on fixed assets which is using up the cash profit they have made and then when their Accountant tells them they have a tax bill to pay, they can’t work out why they don’t have any money to pay the tax bill.

Repayment of debt is very similar to buying fixed assets in as much as the principal of the debt you are repaying is using up your cash profit. Some businesses take out too much debt for too shorter a term. This means that they try to pay back their debt too quickly and they run out of cash. Say you buy a $200,000 asset and try to pay it off over 3 years, your monthly repayments will be approx $6,500 whereas if you pay off that debt over 10 years your monthly repayments will only be approx. $2,500. This is a difference of approx $4,000 per month which over a year is $48,000 which for a small business is a lot of money. Often what happens is where a business is trying to pay back debt very fast the taxman gets left out and not paid and so of course the taxman has to take drastic action to recover the tax they are seeking and they will close down the business due to its failure to pay its tax obligations.

A growing business will often have rapidly increasing stock levels and debtors ledger. Due to rapid sales a business has to buy more and more stock and hold larger and larger stocks to keep all of its customers happy. Then the business may have customers who are slow payers and so suddenly the business runs out of cash in the bank. In these situations we say that all the money is tied up in stock and debtors. This in itself is another subject all on its own. However this is another way that you can run out of cash and not be able to pay your taxes.

We have witnessed many, many, times with our clients that when they learn to manage their cash-flow and start a weekly or monthly Automatic Payment for their Income Tax they are tremendously relieved that they are able to keep on top of and ahead of their tax obligations. For us it is very satisfying to see that they can grow their businesses and be successful.

Contact us if you want to set up a new AP to help you manage your tax payments.

Monthly Business Growth Tips Disclaimer

Important: We cannot be held liable should Clients act solely on the basis of the material contained in the Monthly Business Growth Tips. Items herein are general comments only and do not constitute nor convey advice per se. The Monthly Business Growth Tips are issued as helpful guides to our clients. We cannot guarantee that your business will grow if you follow the guide of the Monthly Business Growth Tips as many other factors that can lead to decline are not necessarily influenced by making one change to the way your business operates.