Debt – The Question is How, Not What

With the level of tax debts owed to the Tax Office by Australian small businesses growing every year; currently over $12 billion, there is plenty of advice on what to do if you find yourself not able to pay the Tax Office on time.

Theoretically, it isn’t very difficult:

  • Make contact with the Tax Office early rather than letting the recovery action escalate;
  • Enter into a payment plan which allows you to pay off your tax debt on a principal and interest basis over a period of time.

Simple. Done.

But life is rarely simple, and this is far from done.

The reason is that, for the payment arrangement to remain in place, you must keep up to date with all tax lodgements and future tax payments.

This is why we are all asking the wrong question.

The question isn’t “what do I do now that I have a tax debt?”

The question is “how did the tax debt come about in the first place?”

Unfortunately, this is a question that rarely if ever gets asked by the small business owner or their accountant or adviser.

You see, if you can’t identify how the tax debt came about in the first place and fix that problem, there’s every likelihood that you won’t be able to pay the next debt on time either. This not only means that you now owe the Tax Office even more money, it also means that your payment arrangement is in default and your chances of negotiating a new payment arrangement diminish every time this happens.

It’s a slippery slope and one that you don’t want to find yourself on.

So, let’s ask the question – How did the tax debt come about in the first place?

Obviously, the answer to this question will be different for every small business but there are some common causes for not being able to pay your tax debt on time.

 

Undercapitalisation

This is one of the biggest causes of financial problems for small businesses. The majority of small businesses start with an employee making a decision that they will go into business for themselves for whatever reason. Unfortunately, they are often unprepared or uneducated in the needs of their business and take an employee mentality into business ownership. They either don’t understand or are not prepared for the potential issue that, while their customers may pay them 30 days after invoice, they have to pay for wages, stock, materials, tools, fuel etc every week. As their business grows which, after all is what the business owner wants, this problem only gets worse. The result is that the business uses the Tax Office as a bank to help fund its financial needs. The Tax Office is a dangerous and expensive bank to associate with and is best kept away from in that capacity. This problem can be, and needs to be overcome by proper planning and then, once the financial requirements of your business are discovered, properly funding those financial needs.

 

Lack of Profitability

Many small businesses in this country are not as profitable as is commonly perceived. Sure, the business can sometimes help pay for the owner’s car and tax can be saved by proper structuring and planning but often small businesses barely break even after owner’s salaries. It is even rarer still that a small business owner will invest after salary profits back into the growth of the business. This lack of making or retaining profits means that the business never has any spare capital set aside for growth, a slow sales period or a time when customers  aren’t paying on time. Provided you are good at what you do and there is a market for what you do, every small business can be profitable. You need to have a “profit mindset” though. This means that you have to actively drive your business every day towards profit by focusing on the key drivers of your business rather than just “working hard”. This starts with analysing your business and knowing your numbers so that you know which areas of your business to work on in order to maximise profitability. It’s a process which very few small business owners go through which is a shame because it can change your business and your life for the better.

 

Lack of Cashflow

Regardless of all the profit in the world, unless you closely monitor the cashflow of your business, you could find yourself in serious trouble.

You need to constantly be managing the following areas of your business:

  • Stock Levels (i.e. stock sitting on the shelf is eating up your cash)
  • Debtor Days (i.e. every day a customer doesn’t pay you is a day you go without cash)
  • Work in Progress or Job Days (i.e. if you invoice customers or clients at the end of a job, the longer it takes you to finish the job, the longer you go without cashflow)
  • Business Expenses (i.e. expenses should be viewed as investments into the profitability of the business and closely monitored)

I understand that none of this is rocket science and yet, in the hectic life of a hard working small business owner, these issue are often overlooked to the financial detriment of the business.

 

Parkinson’s Law

Ever heard of Parkinson’s Law?

It’s the principle where, among other things, if you have a certain amount of money in the bank, you always find a way to spend that amount of money. Most small business owners manage their business’ cashflow by bank balance and gut feel. This means that they know what the bank balance is, they have an idea of what deposits are going to hit the account in the next while and they have an idea of their immediate cash needs or amounts owing so they make decisions on how much money they need or can spend based on that.

This is the breeding ground of Parkinson’s Law.

The problem is that, with any business that has debtors, stock or staff, it is impossible to have a true picture of what cash you require using the bank balance and gut feel business management method. In the absence of proper cashflow planning, Parkinson’s Law dictates that you will always overspend in the short term which leads to medium and long term cashflow problems. This often results in unpaid tax debts and other serious financial issues.

 

Too High Owner Drawings

The last major issue for small businesses is where the business actually performs quite well but the owners draw more money to live on than the business makes. So, for example, the business profit before owner drawings is $250,000p.a. but the owners draw $300,000p.a. to fund their lifestyle. This happens more often than you would think possible and often happens because of the employee mentality we mentioned earlier. Employees are used to being paid with the tax already deducted from their wages so that whatever cash they receive is available for them to spend. When they start a business, they often increase their lifestyles to match the increase in cash flowing through the business giving little thought to the fact that a large chunk of that cash isn’t theirs.

Education, planning and personal cashflow management is the key here.

So there they are, some of the main issues resulting in a small business being unable to pay its tax debt. If you are one of those small business owners with an outstanding tax debt, instead of asking how you go about paying the debt off, ask yourself how the tax debt got there in the first place. Then start to plan, monitor and actively drive your business to better performance and higher available cash flow.

You’ll be glad you did.