Profit on paper doesn’t mean you’re able to pay the tax bill when it comes. If tax time is always leaving you short on cash, there are 3 things you need to know:
- Tax is calculated on profit, and profit is a paper number. The cash behind it may already be tied up in unpaid invoices, stock, equipment, and loan repayments.
- Several things that drain your bank account never reduce your tax bill, so the two move apart all year-round.
- The solution starts with an accountant who shows you the difference between your taxable profit and your free cash. Once you can see that gap, you know how much needs to go into your tax bucket.
For example, if your accountant says the business made $120,000. Then the tax bill arrives, and the account doesn’t have the money to pay it. It feels like the profit figure must be wrong. But it’s usually right, and the cash went somewhere legitimate.
Profit and Cash Are Two Different Reports
Your profit and loss counts income when you invoice and expenses when you incur them. Your bank account only moves when money moves. This gap, which many small business owners don’t see, is what makes tax time stressful.
Read more: Why a busy business can still be short on cash.
Where the Cash Actually Goes
Four destinations absorb most of your business’s cash:
- Unpaid invoices: If debtors grew by $40,000 this year, that’s $40,000 of profit you’ve been taxed on that’s still in your customers’ accounts. Debtor days is the KPI that shows this building.
- Loan principal: Only the interest on your ute, equipment or premises loan reduces profit. The principal comes straight out of cash and doesn’t appear anywhere on the P&L. On a $60,000 equipment loan, that can be $15,000 a year of invisible outflow.
- Stock and materials: Money on the shelf is profit that hasn’t turned back into cash yet.
- Drawings: What you take out for yourself isn’t a business expense. The tax bill is calculated before it.
Run those four against a $120,000 profit, and it’s common for less than half to exist as spendable cash by the time the bill lands.
The Catch-Up Problem
In your first profitable year, the ATO often isn’t collecting much tax during the year itself, so the full bill lands months later, after the money has already been spent. From there, the ATO asks you to pay tax in advance through quarterly PAYG instalments, based on that good year.
So you can be paying last year’s bill and this year’s instalments at the same time. That double-up is what catches most growing businesses.
Know the Difference Between Free Cash and Taxable Profit
Start with an accountant who can show you the difference between your taxable profit and your free cash. Taxable profit is the number the ATO works from. Free cash is what is left to spend once debtors, stock, loan principal and drawings have taken their share. Most owners only ever see the first number, which is why the tax bill keeps arriving as a surprise.
Once you can see both, you can work out how much of every dollar coming in needs to go into a tax bucket, instead of guessing.
Then build the bucket. Open a second bank account just for tax.
Every time money comes in, move your percentage into that account straight away. For most trading companies, 15% to 25% of revenue is enough to cover income tax and GST. Your accountant can set your exact number from last year’s figures.
Do the same for super. Super now leaves your account with every pay run, so put it aside on payday too.
Then check the account once a month against a rolling cash flow forecast. That way, the January and April crunch periods show up months ahead, while you still have time to make any needed adjustments.
So now when the tax bill arrives, the money is already there waiting for it.
If tax time keeps catching you short, book a free discovery call and we’ll show you the difference between your taxable profit and your free cash, then set your number. We are here to help you plan your next steps.
Growth iQ is an accounting and business advisory firm based in Malvern. We support owners across Adelaide in construction, trades, and specialised services with tax and compliance, bookkeeping and payroll, and Agile CFO services.