P&L
When you’re trying to work out how well your business is doing, one of the most powerful tools in your financial arsenal is your profit and loss account (P&L).
This is a simple set of figures that will give you a summary of what your business has spent and sold, normally in the previous 12 months.
By deducting what you’ve spent from what you’ve sold, you’ll discover what profit or loss your business has made. It really is that simple.
Limited Companies must produce a profit and loss account every year
If you run a limited company you will need to produce a profit and loss account every financial year to give to Her Majesty’s Revenue & Customs (HMRC). They will use it to assess your business for corporation tax.
If you are self employed or in a partnership, you probably won’t have to produce a formal P&L. But it’s a good exercise to go through anyway, as it shows you what’s happening in your business. Plus the information you prepare will help you fill out your self-assessment tax return.
A P&L will also be necessary if you want to apply for a mortgage, take out a loan, or get other financing for your business.
A good P&L starts with accurate financial records
A good profit & loss sheet starts with keeping accurate financial records. This is something that is required by law, and it means getting a receipt for everything you buy, and keeping a copy of every sale or invoice you issue.
You should also keep records of any other income you get, how you spend petty cash, and personal payments made for goods (for example if you run a shop, you need to record when you take goods and how you pay for them).
If you run a limited company you will also need to keep a record of any money you take out of the company for personal use, or any personal loans you make to the business.
You categorise revenue in one of two ways, and expenditure in one of three ways to create your P&L:
Business income – sales
You need to keep a record of all sales within the business with documents to back that information up. If you run a shop, your till roll will be the documentation. Or if you issue invoices, they will count. You also need to keep paying-in slips and all your bank statements. These all work together to prove how much money is coming into your business.
Business income – other
On top of sales, you might get income from other sources. For example your business might earn interest on bank accounts, or you may rent part of your premises out to other businesses. This is where you record personal money you put into your limited company.
Cost of sale
This is the first way of recording money out of your business. It relates to the basic cost of creating your product. For example, if you get an order for 10 widgets and so have to buy 10 tubs of goo, those tubs are counted as cost of sale. You wouldn’t buy them until you needed product.
There are other cost of sale items, including labour to produce it, machine hire and some other production costs. Cost of sale does not normally apply if you only deliver a service.
Business expenses
These are all of the ongoing expenses that you must incur to run your business, such as premises, employees, and general administration. Your accountant will advise which expenses should be recorded here. Sometimes expenses are not allowed for tax purposes and have to be added back before your taxable profit is calculated – again your accountant will advise how this affects you.
Cost of equipment
Finally, you record the costs of any equipment you have bought or leased for long-term use. These items are known as fixed assets or capital items, and might include computers, vans, furniture and machinery.
Rather than record the financial hit of a piece of equipment in one year, you can spread it over a number of years. For example if you buy a computer for £300, you might decide to account a cost of £100 for three years. This is known as depreciation. Bigger businesses need to keep a fixed asset register.
Now you have categorised all your sales and costs, you can work out your profit & loss.
The sales and other income are added together to create a figure known as your turnover. If you then deduct the cost of sale, this is your gross profit. Finally, deduct business expenses and cost of equipment to get your net profit. This is the figure you will be taxed upon.
Just so we all understand the impact, for a partner earning £250,000 in both the 2009/10 and the 2010/11 tax years, the tax impact of the withdrawal of personal allowances together with the additional rate of Income Tax will be to create an additional liability of a staggering £12,590. This is the extra Income Tax that an individual will have to pay on the same level of income.
To add to the financial burden there will also be an increased payment on account to be made in respect of the 2011/12 tax year, so the additional tax payment due at the end of January 2012 will be £18,885 from the same level of income as the year before. That would total almost £100,000 for a small 5 partner GP practice or firm of lawyers.
Some may argue that the tax only affects the wealthiest in our society. The Office for National Statistics places earners over £150,000 at 0.6% of the population however their Annual Survey of Hours and Earnings excludes any analysis of the self-employed, the very group that will have to find this extra cash on 31st January 2012.
So if we assume it will affect a modest 1% of the population, at which level the tax changes will be effecting around 600,000 people and frankly this is a sufficient number to justify an examination of possible solutions to minimize the impact for so many of those hard working partners and self employed earners who fall into this upper bracket.
Incorporation of Partnerships
There has never been a better time for businesses to give serious consideration to the incorporation of their activities. As a separate legal entity a company is charged to corporation tax which is levied at 28% (small companies at 21%) which has been at similar levels for many years and is more likely to be reduced than increased in the near future.
More importantly the incorporation provides an opportunity to crystallize the value of a business as a capital gain, allowing up to £2,000,000 to be allocated to each partner at a reduced Capital Gains Tax (CGT) rate of 10%.
Although this step triggers an unnecessary liability to CGT it will create a pool of tax paid reserves available to the owners to draw down, free of any further income tax or national insurance, as the business generates sufficient cash flow from its future trading profits. Provided the valuation of the business is sufficient, it should be possible for owners to maintain similar levels of net drawings before and after incorporation whilst keeping overall tax levels to 38%.
Income Splitting
Ever since HM Revenue and Customs lost its battle in the Arctic Systems case in July 2007 they have been trying to limit the impact of the ruling. The case brought to light the need for the Government to review the legislation to ‘ensure that there is greater clarity in the law regarding its position on the tax treatment of income splitting’. To date nothing has been legislated.
In today’s higher income tax environment it is important to try and bring non-earning or low-earning spouses and/or family members into family businesses and sole traders should give consideration to bringing in partners. Provided there is good economic justification for sharing the income and profits across a wider base of taxable individuals, such prudent use of allowance and thresholds must be given serious consideration.
In its simplest form a non-earning spouse undertaking modest administrative tasks for the business could take £20,000 of profits from a 50% partner and reduce the tax liability from £10,000 to £2,700. In incorporated businesses the use of dividends to reward a wider ownership base can keep taxable income levels below critical thresholds.
Deductible Expenditure
Contributions into pension schemes are not quite as dead as some would have us believe. Not yet anyway. Despite the pillage of our pensions by government over the last 12 years, there is still an opportunity, particularly where income is below the crucial £130,000 threshold, to attract higher rate relief until April 2011. After this date relief will be restricted to the basic rate.
The whole area of pension planning is highly complex and fraught with opportunity for missed claims and claw-back of reliefs, so advice from your financial advisor is essential. For the time being however, it remains true that wrapping your savings for the future in an approved pension environment does still provide some tax relief.
And Finally....
Since the Additional Rate Tax is supposedly a temporary measure, any strategy to defer income into future tax years is worth keeping in mind. This is often more easily said than done however there are many investment products available which will effectively ‘roll up’ income and gains to be taxed at a later date when either the tax rate or your income have declined.
As always time is of the essence so take action now if you want the January 2012 tax bill to be less than it might otherwise be. Speak to your accountant or tax advisor today and take the first positive step in lessening the burden that will be falling on your shoulders before you realize it.
When you’re trying to work out how well your business is doing, one of the most powerful tools in your financial arsenal is your profit and loss account (P&L).
This is a simple set of figures that will give you a summary of what your business has spent and sold, normally in the previous 12 months.
By deducting what you’ve spent from what you’ve sold, you’ll discover what profit or loss your business has made. It really is that simple.
Limited Companies must produce a profit and loss account every year
If you run a limited company you will need to produce a profit and loss account every financial year to give to Her Majesty’s Revenue & Customs (HMRC). They will use it to assess your business for corporation tax.
If you are self employed or in a partnership, you probably won’t have to produce a formal P&L. But it’s a good exercise to go through anyway, as it shows you what’s happening in your business. Plus the information you prepare will help you fill out your self-assessment tax return.
A P&L will also be necessary if you want to apply for a mortgage, take out a loan, or get other financing for your business.
A good profit & loss sheet starts with keeping accurate records. This is something that is required by law, and it means getting a receipt for everything you buy, and keeping a copy of every sale or invoice you issue.
A good profit & loss sheet starts with keeping accurate financial records. This is something that is required by law, and it means getting a receipt for everything you buy, and keeping a copy of every sale or invoice you issue.
You should also keep records of any other income you get, how you spend petty cash, and personal payments made for goods (for example if you run a shop, you need to record when you take goods and how you pay for them).
If you run a limited company you will also need to keep a record of any money you take out of the company for personal use, or any personal loans you make to the business.
You categorise revenue in one of two ways, and expenditure in one of three ways to create your P&L:
Business income – sales
You need to keep a record of all sales within the business with documents to back that information up. If you run a shop, your till roll will be the documentation. Or if you issue invoices, they will count. You also need to keep paying-in slips and all your bank statements. These all work together to prove how much money is coming into your business.
Business income – other
On top of sales, you might get income from other sources. For example your business might earn interest on bank accounts, or you may rent part of your premises out to other businesses. This is where you record personal money you put into your limited company.
Cost of sale
This is the first way of recording money out of your business. It relates to the basic cost of creating your product. For example, if you get an order for 10 widgets and so have to buy 10 tubs of goo, those tubs are counted as cost of sale. You wouldn’t buy them until you needed product.
There are other cost of sale items, including labour to produce it, machine hire and some other production costs. Cost of sale does not normally apply if you only deliver a service.
Business expenses
These are all of the ongoing expenses that you must incur to run your business, such as premises, employees, and general administration. Your accountant will advise which expenses should be recorded here. Sometimes expenses are not allowed for tax purposes and have to be added back before your taxable profit is calculated – again your accountant will advise how this affects you.
Cost of equipment
Finally, you record the costs of any equipment you have bought or leased for long-term use. These items are known as fixed assets or capital items, and might include computers, vans, furniture and machinery.
Rather than record the financial hit of a piece of equipment in one year, you can spread it over a number of years. For example if you buy a computer for £300, you might decide to account a cost of £100 for three years. This is known as depreciation. Bigger businesses need to keep a fixed asset register.
Now you have categorised all your sales and costs, you can work out your profit & loss.
The sales and other income are added together to create a figure known as your turnover. If you then deduct the cost of sale, this is your gross profit. Finally, deduct business expenses and cost of equipment to get your net profit. This is the figure you will be taxed upon.
Tax strategies to consider in a high tax environment
The era of the Additional Rate Tax has begun. Partners and the self employed, in fact all non-PAYE earners, who clock up income over £150,000 during the 2010/11 fiscal year will be hoping that the new 50% rate will go away, but it won’t and it is no use burying our heads in the sand. The countdown to the payment of this extra tax on 31st January 2012 has well and truly begun.Just so we all understand the impact, for a partner earning £250,000 in both the 2009/10 and the 2010/11 tax years, the tax impact of the withdrawal of personal allowances together with the additional rate of Income Tax will be to create an additional liability of a staggering £12,590. This is the extra Income Tax that an individual will have to pay on the same level of income.
To add to the financial burden there will also be an increased payment on account to be made in respect of the 2011/12 tax year, so the additional tax payment due at the end of January 2012 will be £18,885 from the same level of income as the year before. That would total almost £100,000 for a small 5 partner GP practice or firm of lawyers.
Some may argue that the tax only affects the wealthiest in our society. The Office for National Statistics places earners over £150,000 at 0.6% of the population however their Annual Survey of Hours and Earnings excludes any analysis of the self-employed, the very group that will have to find this extra cash on 31st January 2012.
So if we assume it will affect a modest 1% of the population, at which level the tax changes will be effecting around 600,000 people and frankly this is a sufficient number to justify an examination of possible solutions to minimize the impact for so many of those hard working partners and self employed earners who fall into this upper bracket.
Incorporation of Partnerships
There has never been a better time for businesses to give serious consideration to the incorporation of their activities. As a separate legal entity a company is charged to corporation tax which is levied at 28% (small companies at 21%) which has been at similar levels for many years and is more likely to be reduced than increased in the near future.
More importantly the incorporation provides an opportunity to crystallize the value of a business as a capital gain, allowing up to £2,000,000 to be allocated to each partner at a reduced Capital Gains Tax (CGT) rate of 10%.
Although this step triggers an unnecessary liability to CGT it will create a pool of tax paid reserves available to the owners to draw down, free of any further income tax or national insurance, as the business generates sufficient cash flow from its future trading profits. Provided the valuation of the business is sufficient, it should be possible for owners to maintain similar levels of net drawings before and after incorporation whilst keeping overall tax levels to 38%.
Income Splitting
Ever since HM Revenue and Customs lost its battle in the Arctic Systems case in July 2007 they have been trying to limit the impact of the ruling. The case brought to light the need for the Government to review the legislation to ‘ensure that there is greater clarity in the law regarding its position on the tax treatment of income splitting’. To date nothing has been legislated.
In today’s higher income tax environment it is important to try and bring non-earning or low-earning spouses and/or family members into family businesses and sole traders should give consideration to bringing in partners. Provided there is good economic justification for sharing the income and profits across a wider base of taxable individuals, such prudent use of allowance and thresholds must be given serious consideration.
In its simplest form a non-earning spouse undertaking modest administrative tasks for the business could take £20,000 of profits from a 50% partner and reduce the tax liability from £10,000 to £2,700. In incorporated businesses the use of dividends to reward a wider ownership base can keep taxable income levels below critical thresholds.
Deductible Expenditure
Contributions into pension schemes are not quite as dead as some would have us believe. Not yet anyway. Despite the pillage of our pensions by government over the last 12 years, there is still an opportunity, particularly where income is below the crucial £130,000 threshold, to attract higher rate relief until April 2011. After this date relief will be restricted to the basic rate.
The whole area of pension planning is highly complex and fraught with opportunity for missed claims and claw-back of reliefs, so advice from your financial advisor is essential. For the time being however, it remains true that wrapping your savings for the future in an approved pension environment does still provide some tax relief.
And Finally....
Since the Additional Rate Tax is supposedly a temporary measure, any strategy to defer income into future tax years is worth keeping in mind. This is often more easily said than done however there are many investment products available which will effectively ‘roll up’ income and gains to be taxed at a later date when either the tax rate or your income have declined.
As always time is of the essence so take action now if you want the January 2012 tax bill to be less than it might otherwise be. Speak to your accountant or tax advisor today and take the first positive step in lessening the burden that will be falling on your shoulders before you realize it.
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