Almost every small business owner will tell you that you’re not supposed to show a profit at the end of the year, at least that’s what they heard. That’s a really bad practice for several reasons:
1) It encourages small business owners to make irrational spending choices near the end of the year because “hey, otherwise I’d have to pay taxes on it”. I mean, do you really need an expensive national internet marketing campaign for your construction company located in Hewitt, NJ? Of course not, but we make those type of careless decisions at the end of the year because we are desperate to not show a profit.
2) It exhausts your cash and leaves your company short to start your next year. If you are like most small businesses, all of your profit (if you’re lucky enough to have one) is in your checking account at year end. By using it all to “not show a profit”, you’ve wiped out your ability to have cash to make purchases (either planned or unplanned) at the beginning of the year. You are purposefully putting yourself behind the cash eight-ball.
3) It reduces your chances of getting credit to grow your company. By never showing a profit, you have nothing to show a creditor in terms of your ability to generate income. It appears as if your company is barely surviving and thus not worthy of credit that you might need to fund expansion or major equipment purchases.
4) It means that you’ve given your company an interest-free loan. Many small business owners take a year-end “bonus check” to eliminate the profit. This works if you are a sub-S corporation, but it is essentially the same thing as letting your company borrow your salary throughout the year while you pay for things in your personal life on credit.
5) Lastly, it reduces the value of your company when it comes time to sell. If you work for 20 to 30 years to grow your company, add employees, increase your service area, build a reputation, but always show a loss or, at best, a small profit, you significantly reduce the value of your company when it comes time to offer it for sale when you’re ready to retire. Who wants to buy a company that has not shown a profitable year since its inception? The most that you will get out of it will be the value of the hard assets and maybe a little goodwill, instead of the multiple of the average annual profits.
So what is the right way to approach year-end? That starts on January 1st with a cash management system that calculates your profit, your pay and your taxes and puts them all aside as you go through your year. A good system would have cash ready for you to get paid what you’re worth on a regular basis, take profits out of the company on a quarterly (not annual) basis and have money set aside to pay the taxes for all of that – regardless whether you are a Sole-Proprietor LLC or a registered Subchapter S Corporation. Does such a proven system exist? Yes, it’s called Profit First. For more information on how it can help you, contact us today.