Financial Reporting and Tax Reporting

Important to Know: Financial Reporting and Tax Reporting I always enjoy having this discussion, the differences between financial reporting and tax reporting. Tax planning does not have to damage financial presentation as the small business can have the best of both worlds. What’s not to like when taxes are minimized while demonstrating solid financial statements … Continue reading “Financial Reporting and Tax Reporting”

Important to Know: Financial Reporting and Tax Reporting

I always enjoy having this discussion, the differences between financial reporting and tax reporting. Tax planning does not have to damage financial presentation as the small business can have the best of both worlds. What’s not to like when taxes are minimized while demonstrating solid financial statements that will impress lenders.

Let’s start with a very basic discussion of accounting methods. Financial reporting will use the accrual method most normally which recognizes revenue when earned and expenses when incurred. There will be accounts receivable and accounts payable on the balance sheet and earnings on the income statement will include the effects of each of these accounts. Using the accrual method for income tax reporting will likely cause the highest possible income and the highest tax exposure.

The accounting method usually most favorable for income tax purposes relates to the cash basis. The cash basis method of accounting recognizes revenue when cash is actually received and expenses when paid. This will allow a business to escape paying taxes on large receivables in the current year postponing to the following year when funds are actually collected. It is not an uncommon strategy for a small business to pay down it’s cash balance to the extent there are accounts payable. Remember, expenses are recognized when paid under this method of accounting so paying incurred expenses will create a deduction for income tax purposes.

For purposes of this discussion, let’s discuss one other difference regarding financial reporting and tax reporting. This major difference would involve the acquisition of fixed assets. Fixed assets would be machinery and equipment or office equipment such as desks and computers. Let’s suppose that on July 1st of 2015, a business buys $25,000 in computers. The computers will last for five years. For financial reporting purposes, a depreciation expense in the amount of $5,000 will be taken each year. For the first year in 2015, a depreciation deduction in the amount of $2,500 will be charged against income as the asset was acquired and placed in service midyear. For income tax purposes, current tax law allows for the immediate expensing of up to $25,000 of fixed assets placed in service during the year. Therefore, there is now available an additional depreciation deduction for tax purposes in the amount of $22,500 ($25,000 les $2,500).

Nothing brings home the point of a discussion better than an example. Suppose a new small business started on January 1, 2015. For the year ending December 31, 2015, this business has a net income of $47,500 for financial reporting purposes. This includes accounts receivable of $50,000, accounts payable of $25,000, and depreciation of $2,500 on $25,000 of computers purchased on July 1st of the same year. Should this business pay tax on $47,500? What if this business elects to use the cash basis method of accounting for income tax reporting? If it does, the conversion from the accrual to cash basis method will involve reducing net income by $50,000 in accounts receivable as the business has not received these earnings in cash. However, net income will have to be increased by $25,000 for the accounts payable balance. This group of expenses has been incurred but remains unpaid at year end. Cash basis net income is now adjusted downward to $22,500. Don’t forget, this business can claim an additional depreciation of $22,500 if it elects to expense up to the permitted limit of $25,000. For tax purposes, taxable income is reduced to zero, legally. For Internal Revenue Service purposes, this small business simply needs to demonstrate how it got from the financial statement to the tax return.

Please remember, this example does not include a discussion of deferred income taxes that is the result of using different methods of accounting regarding financial reporting and tax reporting. This is a discussion reserved for later at a more advanced level. This discussion does illustrate that a small business can display it’s true financial position and results of operations while legally minimizing income tax exposure. It also serves to put the small business owner on alert that when someone asks to see a copy of the tax return to make a loan eligibility analysis, make sure to include a copy of the financial statement and be prepared to explain why they are different. This discussion will also serve to alert loan underwriters to ask for both financial statements and tax returns and to understand why they are different.

Challenges Facing Tradespeople and Small Businesses

For some, being in the trades is just a job and a means to an end. For others, it’s a calling – a part of their very existence. Some tradespeople hold themselves to the highest of standards and hold true to the things they believe and care about. The challenge for any homeowner is to find a tradesperson who cares about and loves what they do – a tradesperson who is professional in appearance and in how he or she conducts business.

According to a recent survey, 58% of homeowners say they find it difficult to find a tradesperson they trust to help with either home repairs or improvements. Women are more likely to find it “very difficult” to find a tradesperson they trust to help with home repairs or improvements. In the United Kingdom alone, almost £2 billion a year is spent to repair botched jobs by tradespeople who were not qualified to do the work.

Although there are many trustworthy tradespeople throughout the world, why do so many homeowners experience difficulty finding an honest, reliable, professional tradesperson? The answer is not easy, but I will attempt to share my experience and opinion.

I have over 30 years experience as a tradesman, with experience in; building construction, plumbing, tiling, plastering and decorating. As a young man, I enjoyed going to school, but my focus was always on earning a living and raising a family. As a result, I decided to leave home during my late teenage years to attempt to make my mark on the world. Once out there, although I had good work-ethics, I found it difficult to land a good job because I did not possess the ‘qualifications’ required, nor did I have a University degree. Consequently, the only jobs available to me were labor jobs or working at a convenience store. Fortunately, I found a tradesman who hired me and jump-started my career by teaching me how to lay tile. From that point, I learned the building, plumbing, plastering and decorating trades.

Most Schools are under pressure to keep kids in the classroom until they graduate. Unfortunately, there are many youngsters who are either not academically inclined and have difficulty with studies, or for one reason or another have become a disruption to classmates. As a result, more Schools are forming a Department called, “Alternative Provision,” or “Alternative Learning.” This is where many non-academic and/or disruptive children are finding themselves.

Alternative Provisional children are exposed to alternative forms of learning such as, the Work-Study Program. Here is where youngsters can apply to a Trades School or College, and they can experience on-the-job training doing such things as; working in the trades, learning how to be a beautician, and other fields that may not require a University degree. Thus, we have an abundance of youngsters becoming tradespeople because they cannot find gainful, employment due to the lack of a University degree or another specialized training.

There are many people who are in the trades because ‘it’s the only thing they can do,’ or because it’s the only thing they are qualified to do. I believe most tradespeople want to do a good job and take pride in their work. The challenge is, many tradespeople do not possess the skills to set themselves apart from the rest. They are not good Business people. I have listed some ways tradespeople fall short of a professional, high quality standard that will deliver positive outcomes in their business:

• They write estimates on a napkin or piece of dirty paper

• They show up to appointments late and are not dressed in an appropriate manner

• They forget to send out invoices or forget to follow up on outstanding invoices

• They do not schedule their time efficiently and live a, ‘feast or famine’ existence

• They do not provide clean, professional customer estimates and invoices, nor do they have systems to track them

• They do not manage conversations with customers. A customer may say one thing today, and another thing tomorrow. If you do not have record of that conversation, the job will turn into confusion and become a ‘he said-she said’ challenge

• They do not carefully manage their time and miss or forget to respond to customer calls

• They do not have systems in place to maintain an accurate customer base

• They find themselves having to “chase customers” for payment

• They do not have a Professional Presence

The list can go on and on, but I think you get the picture…

Life is good when you’re working. However, there always comes the time when you are not as busy as you would like. This is the time when many tradespeople begin to ask friends for work or they look into joining some website that promises to ‘send them leads.’ I have found these sites to be misleading because they do not address the real issue – helping tradespeople to become more reliable and professional!

These sites charge high fees but do not produce the goods. Let’s be honest; how can anyone refer a “Trusted Trader?” The only referral anyone can give is; “He has done a fantastic job for me, or I would never use him again.”

Unfortunately, this tends to be much like Trip Advisor, where a Hotel may receive high rating by someone, but your experience might be totally opposite…

The one thing any qualified, tradesperson can do is; become more professional at what you do!

I will address ways to become a more professional tradesperson, in my next article.