Tax Planning - Part 2
Welcome to the second instalment in our tax planning series designed to give you a taster of what exactly tax planning is, the process, and why you should do it. In part one, we used the SMART goal setting framework to give an overview and set a baseline understanding. This week will be more about the process with lots of practical tips you can implement now.
In order to complete an accurate tax planning review, we need up to date actual profit and loss figures, and a projection to the end of year so that a full year profit and loss can be prepared. Sounds easy right? Let’s find out!
Being able to run a current profit and loss statement was once the domain of large business with full time accounting teams. It just wasn’t cost effective for smaller businesses, or systems were designed in such a way you really needed to be an accountant to understand them! Thankfully times have changed and small business owners have very good accounting systems available at much lower costs.
Running some reports is only useful however if the system is reconciled up to date. So using Xero as an example, you have your file and the bank feed is setup, meaning that bank transactions are flowing directly from your bank to the Xero file. It is then important that all of these transactions have been reconciled so that reports can be generated showing accurate balances.
Doing that? Perfect! Now let’s really start having some fun! This article is being written in June, so for the purpose of this example, we will run our theoretical profit and loss report for the year to date ending 31 May. Most software packages allow you to run this report showing the previous year as a comparative, and this is important because it allows you to go line by line and look for any amounts that are dramatically different this year compared to last year.
The reason we are doing this is so there is an accurate baseline to project from. For example, the initial P&L might show a high profit and so you go off and buy some new expensive equipment to make use of the $20k instant asset write off rules being extended for small business. There is no issue with that, but if depreciation had been forgotten about in the calculation (which is normally a year end entry), the profit might have been much lower than what was forecast and so it could have been more advisable to delay that purchase. This could have been picked up by running a comparative P&L and when you get down to the depreciation line, this year would have been nil compared to a higher figure in the previous year.
Don’t forget your balance sheet!
Using the depreciation example above, it would be incorrect to assume the same expense from the prior year would be the same for the current year. Small businesses have access to depreciation pools which can be more aggressive than standard depreciation methods, and a purchase or sale will also impact how much depreciation is available in the current year.
Leading up to year end is also a perfect time to consider the recoverability of trade debtors which is not something you would see just looking at the profit or loss.
Projected income & expenses
So by now we have reviewed the profit or loss and balance sheet and determined we are happy with the draft numbers. Now is the tricky bit because there needs to be an estimate of income and expenses. As a baseline, you can extrapolate out based upon the year to date. We then like to talk with our clients to ensure that these figures are accurate and factor in any unusual transactions like a big sale that has just occurred or some repairs that were required due to a break down of a machine or vehicle.
The annualised profit or loss
So with all of the above work completed, we have now have a combined actual and projected profit or loss for the year. This in itself might be a quick process, or it may take more time depending upon the state of your accounting records and complexity of business dealings. Either way though accurate tax planning cannot be completed without it. Hence why part two of this series has been dedicated to getting this right.
Now that we have done the groundwork, our next instalment in the series will look at some strategies to consider implementing before year end.
We do very much hope that this article has helped you in some way. If it has then please feel free to share it to someone who may also find it helpful. And please do not hesitate to contact us if you have any questions or comments.