Episode 5: Budgeting Basics Part 2 (Business)
Updated: Jan 15
In episode 5, we focused on business budgeting, how much to save for taxes, and how to set goals for your business and measure your progress. Whether your business is set up as a sole proprietorship or a corporation, this general advice will be most useful for businesses with an annual gross revenue under $300,000.
Just like last week, I acknowledged that finance and budgeting can be an emotional process, particularly with small businesses where the owner has really put their heart and soul into it. Whenever you get frustrated with business, whether it’s money, customer service, sales, or anything in between, my best advice is to go back to your WHY, or your original mission statement, and let that guide you when your business is evolving.
In this episode, we focused on your most recent Income statement (sometimes called a Profit & Loss statement). If your most recent statement is from last year, you can use that, but I always recommend going with a monthly bookkeeping plan in order to really have your finger on the pulse of your business’s financials. In order to have healthy financial growth, you should be thinking about and measuring your revenues and expenses more than just once per year.
We went through the income statement, line by line, discussing what each line means to you and your business. I have entered a text-based version of the income statement we went through on the video, complete with general targets for your operating expenses, salaries expenses, and net profit targets.
If you are running as a sole proprietorship, or a corporation that does not pay yourself or others on payroll (meaning you take draws without remitting source deductions like tax or CPP, and you end up declaring it as a dividend on a T5 slip at the end of the year), refer to the left column.
If you are running as a corporation, and the corporation pays the owner(s) and any other employees on payroll, refer to the right column.
These targets are very general guidelines, and one size may not fit all. A tip that I gave in the video is to do some research on other companies in your industry, see where their margins are at, and make that your target. All publicly traded companies are required to publicly release their financial statements.
Now, there are 2 major things that aren’t going to show on this income statement, but will still make an impact on your cash flow. So, if you are looking at your net profit and wondering where all that money went, take a look at your balance sheet (we will look more into this statement in a future episode) to see these items:
1. Capital Expenditures: if you purchase a piece of equipment, tool, computer, vehicle, or anything else deemed as a fixed asset, we only claim depreciation on these items, which means the entire purchase doesn’t get put on your income statement, only a prescribed portion of it. Unsold inventory is also in this category, as it does not become a Cost of Goods Sold expense until that item is actually sold.
2. Debt Repayments: You may be paying a lot of cash out to pay back debts, but the only part of that will show up here is the interest portion.
In the video, I explained that when budgeting for business, the main concentration should be on NET PROFIT, which tells us how much we earn after deducting all expenses (except taxes). I want your GOAL to be profit, and make the rest of it fit around that. Here’s what I mean:
• In the left column (sole proprietor, or non-payroll paying corporation), if your operating expenses are running at 30% of GROSS PROFIT, this would mean you’re leaving 70% to pay yourself and your taxes. You can also use some of this to reinvest into your business if you like, but please pay yourself as well. And of course, taxes are not optional.
• In the right column, (payroll remitting corporation), the operating expenses was at 94% of GROSS PROFIT, leaving 5% for the corporation (to reinvest into equipment, employees, office space, anything), and 1% for taxes (see more on this further down). Remember, in this scenario, the corporation has already paid the personal tax on behalf of the owner(s) and employees.
So, we now see that in order to get to our profit target, we need to make some changes to either our COGS expenses, or our operating expenses. So, just like last week, I suggested to go on a hunt with your red marker. Beside each line item in your operating expenses, write a red P (for profit) if that expense truly increases your revenues. If it does not, write a red NP (for no profit). This will help you in determining what can be cut or reduced. You can even drill down further and realize what is or isn’t bringing quality to your product or service.
I believe that if you’re only concentrating on increasing revenue/sales, and not putting any focus into your bottom line, your business will not grow in a substantial way. I discussed a theory called Parkinsons Law, and when it is applied to money says that “Expenditures Rise to Meet Income”. In other words: if you don’t keep your operating expenses in check, and really concentrate on the profit, any increased revenue will just continue to go out the door. If you can be aware of Parkinson’s Law and try your best to break it, you WILL see growth in your business. And again, we sometimes need to go back to our WHY and our original mission and say, can my business make a bigger impact if I’m actually profitable? The answer is likely going to be yes.
HOW MUCH TO SAVE FOR TAXES
Right column, (payroll remitting corporation): In Alberta, for small corporations that qualify as CCPC’s, the tax rate is 12% of your net profit. But that can be very hard to easily save for if you don’t know exactly what your net profit will be at any point in time. So here is a simpler trick: For every dollar that you get in GROSS PROFIT (much easier to track), save 1% for corporate tax for every 5% of profit you want to keep in the corporation (not for personal use, but for future reinvestment). So, if your target net profit is 5%, save 1%. If it’s 10%, save 2%.
Left column (sole proprietor, or non-payroll paying corporation): the calculation is a little more complicated, because we’re dealing with CPP, and possibly other income or expenses. For sole proprietors, I have a very general guideline for Alberta residents ONLY, but keep in mind this is not factoring in any additional income you may receive, or any deductions you may make. I have made the savings quite generous, with the hope that you will save more than you need.
If your gross annual income is less than $30K, save 10% of your GROSS PROFIT for personal taxes$30-45K = 15%$50-100K = 20%$100-250K = 25% (and you should probably think about incorporating at that point)
If you have a corporation and are choosing to go the dividend route, you need to be aware that both the corporation and you will owe tax. This is a lot harder to create a general guideline for, but my best advice would be for every draw you make as an owner, to keep 12% in the corporation to pay for taxes, and then save about 15% of your draw in your own personal account for personal taxes.
EXAMPLE: $1,000 draw = Put aside $120 in the corporation’s tax reserve, and then out of the $1,000 cash, keep $150 in your own personal savings.
NOTE: None of these calculations include GST. Your income statement does not reflect the GST/HST/PST you collect OR the GST/HST/PST you spend. A good rule of thumb is to just put that 5% (or the GST/HST/PST rate is that you collect) into a separate account and never treat it as your own income. When remittance time comes, and you owe less than that amount (after Input Tax Credit deductions), hurray!
If none of this is making sense to you, or you have a hard time forecasting what your entire year’s worth of income is going to be, I highly recommend a monthly bookkeeping service. You will up to date statements every month where you can check on your progress and see if you’re moving towards your goals, and a clear estimate of how much you should be saving or remitting (if you have to pay installments) for taxes. Take the guesswork out of it, spend your time doing what you love in your business, and leave it up to a professional.
TIPS TO MAKE THIS EASIER:
• If you are an owner of a corporation, you are legally required to have separate bank accounts from your personal ones. This isn’t required if you are a sole proprietor, but it’s a really good idea. It makes tracking and bookkeeping so much easier, and if you choose to use a software program like Quickbooks Online where you can set up bank feeds, then you’re not connecting your personal bank account.
• If you use software in your business, take it upon yourself to do a subscription audit every 3 or 6 months. It seems like with all the different subscriptions out there now, it’s so easy to be paying for something you’re not even using anymore
• Book dates with yourself (and/or your accountant/bookkeeper) quarterly to review your business goals, financials, what’s working, what isn’t, etc. I will do a video on this specifically closer to the end of November, when I do my own quarterly review just to show you how I do one and give you some ideas and tips.