James and Megan continuing to dive into the finances of your businesses. In this episode, they discuss two topics that are often pushed to the side, but can really make or break a company.
Today’s Kryptonite: Savings and Taxes!
Why isn’t profit enough?:
- Profit can be enough, the problem is many people mistakenly believe profit is Revenue minus Expenses. What they’re actually calculating is EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. While this can be a good indicator of profitability if you’re comparing different companies, it is not Net Income nor is it a good indicator of Cash Flow.
- EBITDA is where we account for taxes and some savings. What is left after EBITDA is your Net Income, your bottom line, your profit!
- To be successful, you need to maximize your profit, account for taxes, and establish healthy savings (or retained earnings) for your business.
What do we need to know about taxes and savings?:
- Disclaimer: This information is provided to get you thinking about these topics and share some basic information. For your specific situation, please talk with your accountant or tax attorney!
- There are a couple of different approaches to savings depending on what stage of business you’re in and your personal situation.
- If you are just starting out, you still have a job, and you’re not dependent on your business for income, aim to save all of your net income. This will help you build your war chest for when you do transition to pursuing your business full-time. It can fund your income, help you grow the business, or potentially help you hire your first employees.
- If you are dependent on your business for some or all of your income, aim for retained earnings of at least 50 percent. Yes, it sounds like a lot, but you will need this to keep your business financially strong. Remember, your salary is calculated in your company’s expenses under SG&A.
- First and foremost, you need to pay them!
- The major taxes most people are familiar with are Federal (IRS), state, and local taxes. However, as a business owner, you are now responsible for other taxes, such as employment taxes. Depending on how your business is structured, this may include self-employment taxes, social security taxes (both the employee withholdings and the employer portion), unemployment contributions, and any unique local taxes.
- Make sure you’re working with your accountant or tax attorney to understand what taxes are applicable to you in your specific area. They can also help you understand filing requirements. Bottom line: make sure you are paying all the requisite taxes by the deadlines.
How can I make sure I win in these areas?:
- There are several strategies you can use to maximize your savings and minimize your taxes.
- For savings, having a budget for your business can be incredibly beneficial. This will enable you to manage the ups and downs of your business, plan your expenses accordingly, and have the cash flow to weather it all.
- Secondly, keep your retained earnings in a separate account. Most businesses have multiple accounts. You should have one account for your retained earnings and your taxes that you are saving until they are due. You should then have an operating account that you use your the daily operation of your business. Just like in your personal life you have a checking and savings accounts – similar concept. By keeping your accounts separate, you’re not tempted to spend your payroll taxes, thinking you will earn them back before they are due–this is always a bad strategy.
- What about taxes? The good part of operating a business is taxes are calculated not on your revenue (there are some exceptions by location for some tax categories), but on your earnings after expenses have been subtracted. You can minimize your taxes by taking advantage of normal and reasonable expenses. For example, if you have a home office–and it meets the IRS requirements–you can deduct these expenses.
- Vehicles are another place to look for reasonable expenses for your business to pay for that can minimize your taxes. This can take the shape of mileage & tolls that you’re reimbursed for using your personal vehicle or your company could own your vehicle.
- If you’re a solopreneur, consider setting up a retirement plan for yourself. This can be a great way to save for your future and minimize your taxes.
- There are many options, just make sure your run them by your tax professional first!
- If you do not have separate accounts for your operating expenses and your savings, get them set-up and place the appropriate funds in the corresponding accounts.
- Start allocating money towards your retained earnings now. Even if it’s a small amount, build that discipline.
- Meet with your tax professional to see what taxes you’re subject to and what you can do to minimize your taxes.