If you’re new to business, it can be common to lose track of your profits then arrive at the end of the financial year with nothing left to pay your taxes.
Searching for your missing revenue
There are a few reasons why you’ve done well this year but have nothing to show for it. Your profit could be:
- Owed by debtors. Some of your customers may have purchased goods or services from you, without having paid yet.
- Locked up in stock or raw materials. Buying in bulk and having unsold stock adds assets to your balance sheet but decreases your bank balance.
- Used to purchase new assets. If you purchased a new work vehicle, you won’t be able to claim all of it as an expense in the year you bought it. Instead, it’s depreciated over many years.
- Owner withdrawals. All business owners need to support themselves with the profits from their trading but finding a balanced amount to pull out of your business can often be tricky.
Following a prosperous year, you’ve probably had a look at your profit and loss statement and wondered where your earnings went. It’s essential to first understand what this statement actually shows.
Selling on credit
Your profit and loss statement shows all your business’s income (whether received or not) and expenses (whether paid or not) over a period of time.
For example, you may have sold $10,000 of goods on credit a few weeks before the end of the financial year. As a result, you won’t have been paid yet – although this sale will be included in your profit and loss statement.
Your business has $10,000 extra profit listed on your records without having the actual cash to show for it. Of course, the money will be in your bank account after your customer pays.
Reducing the gap
In order to minimize the difference between what your statements say and what your wallet says, try to regularly review your debtors. Follow up any requests for payment and take appropriate action to collect debt if customers miss their due dates.
Paying your creditors early will help reduce the gap, but you should aim to pay as late as possible so your business has higher cash reserves for longer.
Consider using a cloud accounting system that reconciles accounts in real time. You’ll be in a much better place to take timely action by tracking transactions in real time.
Creditors and debtors
All businesses will have some customers who pay on credit, and some suppliers who let them purchase on credit.
It goes without saying that there’ll be a time lag between when these transactions are made and when the actual money changes hands. As a result, your profit and loss statement can show higher ‘Sales’ and ‘Cost of goods sold’ figures – while your bank account stays the same.
Understanding ‘Cost of goods sold’ (COGS)
COGS is the direct cost of buying and creating the goods that you’ll sell to your customers. It’s simply your:
- Beginning inventory ($10,000 for example) for a certain time period, plus
- Inventory purchases ($50,000) during that period, minus
- Inventory at the end of the period ($40,000).
In the above example, your COGS would be $20,000. If you have a manufacturing business, you might also have direct labor to add to this total. Other costs could include freight, storage, or factory overheads.
Many service-based businesses won’t have any COGS as they’re selling their time.
In many ventures, profit gets reinvested with the aim of growing the business. This reinvestment will often be in the form of more stock and more debtors. However, profits can also be used to fund capital expenditure.
If your business reinvests some of its earnings in purchasing a new asset, your balance sheet will show it as an asset while your profit and loss statement will only show the depreciation expense for the current year. Essentially, your bank balance will be lower than what your profit and loss statement suggests it should be.
Withdrawing too much money from your business
You can inhibit the ability of your business to grow by taking too much profit out – while you’ll also have fewer cash reserves at the end of the financial year.
If your business has more than one owner, make sure there are appropriate budgets in place for each one. As long as it’s clearly stated how much profit and how often each owner will be paid, there shouldn’t be any cause for concern about missing revenue via this avenue.
Stay calm and carry on
When the end of the financial year comes around and you’ve made a profit but don’t have any cash in the bank to pay your tax bill, don’t get too worried. Have a hard look to see if your cash is hidden in extra stock, debtors or assets.