Taxation & Tax Tips

Understanding Taxation Requirements for Sole Traders in Australia

Start up business owner

Tim Ricardo Company Director on Bishop Collins

Tim Ricardo

Director

Starting a business can be daunting, no doubt. Having spent 20 years consulting on business start-ups I’d like to take you through the journey of commencing a business, and of course run through the common questions that people have when starting out.

Often people want to give it a try using the simplest and cheapest structure before they spend money on expensive company setups, so a sole trader is usually that first step into business. It should be said that, depending on the business, this may not be the wisest choice of structure depending on your circumstances so I will also discuss this later in the article.

What is a Sole Trader and How are They Taxed in Australia?

A Sole Trader is an individual who operates a business in their personal name. There is no legal distinction between the owner and the business. This means that if you start trading as a sole trader, everything is in your personal name, the trading name, the business assets and of course the liabilities associated with operating the business, which unfortunately includes the tax you will have to pay.

Just like a company or an individual, a Sole Trader is subject to income tax, but unlike a company a Sole Trader’s income tax is calculated as part of their personal income tax return, rather than a separate one like a company. Additionally, Once a sole trader is bringing in over $75K per annum, they must register for and pay Goods and Services Tax.

sole trader workingHow to Register for an Australian Business Number (ABN) as a Sole Trader

From a practical standpoint, you as the business owner will set up a bank account in your personal name and start operating the business. You will need to register for an Australian Business Number (ABN) and have a Tax File Number (TFN) to operate as a sole trader in Australia, although most people already have a TFN because any job will require this before you are paid.

Next, sole traders usually register a trading name and a domain. It’s not compulsory to register either of these but is it becoming more and more common. Australian Securities and Investment Commission (ASIC) operates the business name register and ensures that only unique names are registered throughout Australia so you can search naming availability on their website. Registering a trading name is relatively cheap and can be done for either 1 or 3 years.

Registering a domain can be done through a variety of providers but is usually completed after registering your trading name. Here’s a handy tip: be sure to check the domain is available prior to choosing your trading name!

You may just trade using your own name although not all people have exciting names to start with and you may like to brand your business with a unique name that has not been previously registered.

sole trader enjoying workTax for Sole Traders in Australia

As a sole trader, you’re required to report your business income and expenses on your personal tax return. This means that your business income is taxed at the same rate as your personal income.

People often get confused about sole traders because they think the business is separate from themselves and ask me how much tax they will pay if they can withdraw the money from their bank account. Income as a sole trader is assessable as soon as it is earned, and tax is assessed in your individual tax return in the year of earning. So basically if you have a business profit of $100,000, this is added to your individual taxable income whether or not you have taken it from the business.

Also bear in mind the timing of your income. If you earn this money on the 30th of June but then incur expenses on the next day they will not reduce this income since the income is assessed between the period of the 1st of July to the 30th of June. This is where record keeping becomes critical, because as a sole trader you can be caught with large income in one year and nothing in the next year resulting in a higher than average tax bill.

I’ll give two examples. In the first example you earn all your income in Year one. In the second example, you average your earnings over two years.

 

Example 1 Example 2
Income: Income:
Year 1: $100,000 Year 1: $50,000
Year 2: $0 Year 2: $50,000
Total: $100,000 Total: $100,000
Approx. Tax Payable: Approx. Tax Payable:
Year 1: $25,000 Year 1: $7,500
Year 2: $0 Year 2: $7,500
Total: $25,000 Total: $15,000

So when you examine the two examples, you’ll see you are paying $10,000 more in tax by having all the earnings in one year as opposed to spreading over two years. This is a common problem with taxation of sole traders.

If you are a sole trader, you are not entitled to the same tax benefits and deductions as other business structures, such as companies or trusts. For example, you cannot split business profit with your spouse or claim deductions for certain expenses.

This can make it more challenging to manage your tax bill and may be a reason to consider another business structure.

Business Activity Statements (BAS) and Goods and Services Tax (GST)

In addition to income tax, you are required to pay Goods and Services Tax (GST) if your annual turnover is more than $75,000. With GST you generally start your next journey into the world of Business Activity Statements (BAS). These are generally lodged quarterly and are another stepping stone into business governance which requires you to have a bookkeeping system that will allow you to properly track not only income and expenses but the GST proportions on all of these.

Not all income and not all expenses incur GST and this often results in mistakes so consider using a business bookkeeping service to ensure everything is by the numbers. We offer this to many of our clients as part of our business services and can assist in lodging your BAS and assist in bookkeeping so you can focus on the most important parts of your business – earning money.

On your BAS you may also have other taxes that need to be paid. Any employees (other than you as the owner) you will need to withhold tax and pay, this is called Pay as you go withholding or PAYGW.

Also once you have received that dreaded first tax bill on your business earnings the ATO will start charging your quarterly tax called a Pay As You Go Instalment or PAYGI. PAYGI is an estimate of your earnings and can be varied but be careful not to vary these instalments down if you are still earning the income because the ATO have penalties if you get this wrong.

Restructuring to Another Entity

There are various reasons why a sole trader may consider restructuring to another entity. One of the main reasons is to protect personal assets from business liabilities.

For example, if you operate as a sole trader and your business incurs debts or legal action, your personal assets may be at risk such as your home. By restructuring to another entity, such as a company or trust, you may be able to protect your personal assets from business liabilities.

Another reason to consider restructuring is to take advantage of tax benefits and deductions. Companies and trusts may be eligible for tax benefits and deductions that are not available to sole traders. For example, companies may be able to claim deductions for salaries and superannuation contributions for employees, while trusts may be able to split income with beneficiaries.

A company pays tax of 25% so taking the example of the income above if you are earning over $100,000 you personally will be paying $25,000 in tax with money over this amount being taxed at a higher rate. As a sole trader if you earn $200,000 in tax you will pay around $65,000 in tax which as you can see is around $40,000 or 40% on your second $100,000 of income. If you are wanting to retain this money to invest in growing the business a company will only pay $25,000 on this money so it is important to think about restructuring as your business grows.

How Bishop Collins Accountants Can Assist

If you’re considering restructuring to another entity, Bishop Collins Accountants can assist you throughout the process. We can provide advice on the most appropriate business structure for your needs and help you to register your new entity. We can also assist with transferring your assets and liabilities to the new entity and provide ongoing support with compliance and tax obligations.

In addition, if you are currently operating as a sole trader, we can help you to minimise your tax bill and maximise your deductions. We can provide advice on allowable deductions, such as home office and motor vehicle expenses, and help you to structure your business to take advantage of available tax benefits.

Taxation requirements for sole traders in Australia can appear simple to start with but as you can see it may not be the best structure long term and restructuring to another entity may be a viable option for some businesses.

Bishop Collins Accountants can provide valuable assistance throughout the restructuring process and help you to optimise your tax position. Get in touch with us today to learn more about our services and how we can assist you with your taxation requirements.

Business Coaching

How to Start a Company in Australia

looking up at sky scraper building

Glenn Harris

Glenn Harris

Director

Thinking about how to start a company in Australia can initially seem to be an overwhelming task, particularly if this is something new to you. At Bishop Collins we are frequently asked “how do I start a company” and “how much to start a company in Australia” by both new and existing clients. This question is asked for a wide range of reasons. Some of the most common reasons for wanting to start a company include:

  • A small business is growing, and the owner wants to transition from a sole trader to a company.
  • To start a new business or acquire an existing business.
  • A multinational company wants to start operating in Australia
  • A trustee for family trust.
  • A trustee for a Self-Managed Superannuation Fund (SMSF).
  • To be used as an investment vehicle.

Read on to learn more about how to start a company in Australia and the considerations you may need to make.

large commercial building siteShould I use the Company Structure for my Business?

There’s a variety of reasons our clients choose to use a company structure, and it depends on each client’s individual circumstances. Some of the key reasons why we advise clients to use a company structure for their business or for their investment vehicle include the following:

Minimise Income Tax

For an operating business in Australia, the corporate tax rate is currently 25%. This is a very favourable tax rate when compared to the top marginal tax rate of 47%. The tax paid is retained in the company as a franking credit. This credit will be attached to future dividends paid by the company. The shareholder will receive a tax rebate for this franking credit on receipt of the dividend.

Asset Protection/Limited Liability

Operating your business as a company allows you to separate the risks associated in running the business from your personal assets. This means if a material risk arises in the business, i.e. litigation, your personal assets, such as your family home, will likely be protected from this risk.

Multigenerational Operation

A company has no fixed expiry date when established, unlike a trust. The Corporations Act in Australia allows a company to continue indefinitely until it is wound up.

New Business Partners

A company provides the flexibility to add new partners to your business in whatever proportional allocation is desired. By allotting new shares or selling existing shares, you can easily add new partners to your business to allow your business to grow. Share allotment also provides an excellent opportunity to issue shares to your employees as an incentive to their performance. This can be done under a well-defined employee share scheme.

business team learning how to start company in australiaWhat Guidance is Available for Running a Company in Australia?

The Corporation Act 2001 is the principal Commonwealth legislation in Australia which regulates operating a company in Australia. It provides guidance on how to create and operate a company in Australia.

The Act is administered by the Australian Securities & Investments Commissions (ASIC). Under the Act, ASIC has significant powers to ensure directors of companies operate in accordance with the law and associated regulations.

If you are starting a company in Australia, you should be familiar with your rights and obligations under the Corporations Act, in particular those relating to directors’ duties. These key responsibilities include:

  • Make decisions in good faith and for a proper purpose.
  • Do not have a material personal interest in the decision and make it in the best interests of the company.
  • Find out and assess how any decision will affect your company’s business performance, especially if it involves a lot of the company’s money or could have a material impact on the company’s reputation.
  • Keep informed about your company’s financial position and performance, ensuring your company can pay its debts on time.
  • Get trusted professional advice when you need assistance to make an informed decision.
  • Make full and frank disclosure about any material personal interests you do have.

Further detailed information regarding your director responsibilities can be found on the ASIC website here. It is very important you understand your obligations under the Act before you become a director. Penalties apply for noncompliance with the law.

person working at laptopHow to Start a Company in Australia

You can register your company through the Australian Government’s Business Registration Service here. However, due to the complexities in doing so, most people use a private service provider such as their accountant or solicitor to incorporate their company.

Under recent legislative amendments, all directors now require a Director ID number before they are appointed as a director of a company. A Director ID is a unique identifier that a director will apply for once and keep forever – which will help prevent the use of false or fraudulent director identities. More information about Director IDs can be found on the ASIC website here.

Once your company is incorporated, there are some key ongoing legal obligations you will need to ensure your company complies with. These include:

  • Setting up a registered office and principal place of business.
  • Keeping the company details up to date with ASIC by lodging the appropriate forms in a timely manner. Fees apply for late lodgment of ASIC forms. Most forms are due for lodgment with 28 Days of the date of change.
  • Keeping appropriate financial records.
  • Reviewing your annual ASIC statement and pay the annual filing fee.

Further information on these key requirements can be found at the ASIC website.

window signage pay your tax now hereTaxation and Other Obligations

In addition to the requirements under the Corporations Act as a company director, you will also need to ensure your company meets its obligations under various other Commonwealth and State legislation. These will include:

Taxation

Tax is administered by the ATO and may include Income Tax, Goods & Services Tax, PAYG withholding, Fringe Benefits Tax.

Employees

Obligations in relation to employees include National Employment Standards, Work Health and Safety Act, Superannuation Guarantee, Payroll tax, worker compensation insurance.

Compliance with Other Laws

Depending on the company’s business operations, these may include Anti-money laundering with AUSTRAC, land tax registration, fair trading, privacy laws, franchising code, intellectual property, environmental protections, importing and exporting goods.

Let the Professionals Help you Start your Company

If you’re looking for advice on how to start a company and the requirements involved in doing so, getting professional advice is a smart course of action. The team at Bishop Collins are experts in every aspect of company structure and business establishment and provide solutions to ensure your company is operating legally and profitably.

Please reach out to us at Bishop Collins if you would like to seek professional advice on how to start a Company.

NOTE: Information regarding company incorporation and operations sourced from www.asic.gov.au current at December 2022.

Business Coaching

How to Successfully Apply for a Business Loan

broker advising couple how to apply for business loan

Tim Ricardo Company Director on Bishop Collins

Tim Ricardo

Director

I’m going to start this article with a true story about a client of mine that I have looked after for almost 17 years; let’s call this client Joe.

Joe applied for a business loan to purchase a second factory bay for his business. The year was 2007 and we had recently experienced a fairly major property boom (which sounds somewhat familiar). His first factory bay had increased in value and so it looked like he would have around a 20% equity amount against both properties, so he applied for the loan with a second tier lender since the major banks were requiring a higher deposit and he didn’t have the available cash flow in his business.

The value of the two factory bays was around $750,000 and he was getting a loan of $600,000. Joe was originally offered what appeared to be a reasonable loan from the lender with a market variable interest rate which, at the time, was 8.75%.

Joe was paying his repayments on time and was not having any problems with the loan. However, in 2008 after purchasing the property, the global financial crisis occurred and the lender decided to exercise its right to re-value the property which on paper was now worth less than $700,000. This means the loan of $600,000 was now above 80% of the value of the property and subsequently the lender increased their loan interest rate to the default interest rate of around 15%. The loan fine-print stipulated that the lender was allowed to do this, and Joe, with no available cash and no other lenders available given his situation, had no option but to pay the additional interest. This crippled his business for over 10 years until it had the financial capacity to refinance the loan to a lender with more reasonable rates.

I wanted to write this as a warning to businesses when applying for business lending to make sure they are aware of how lenders look at loans. As the applicant, it is on you to understand the terms and risks associated with a business loan. With that out of the way, let’s take a further look at how to apply for a business loan.

large factory bay interiorWhy Do You Need a Business Loan?

Businesses from time to time require funding for various purposes. It’s the very nature of doing business. When asked “How to Apply for a Business Loan?” the common response is, “what is the purpose of the loan?” Answering this question is important because the purpose of your loan will guide the way forward in your application.

You may be looking at expanding your business, purchasing or replacing equipment or just seeking some additional cash for the purpose of improving general business cash flow. It may be any combination of these purposes, but most loans will have one of these in mind.

When you apply for a business loan to the bank, you are often confronted with a long list of questions and information requests which business owners find frustrating. You may ask yourself: why do they need all this information? You may have been the most reliable and responsible customer in the past, however ultimately through all the forms and questions they will be looking for two things: Serviceability and Security. I will explain these two concepts further below, but it is important to understand that your lending rates and terms will depend on how you stack up with your Serviceability and Security.

Loan Serviceability

Lenders often refer to your ability to make repayments as serviceability, meaning your ability to service or pay for a loan.

Loans have three main variables which affect the repayment:

  1. Loan Amount
  2. Term of the Loan
  3. Interest Rate

Loan repayments are a result of these variables and your business’s free cash flow will determine whether you can afford the repayments on the loan. The bank will request your profit and loss statement and tax returns to show how much income you are generating over and above expenses to help work out servicing.

The purpose of a loan is a major factor that drives the term of the loan and can have a major effect on serviceability. For example, if you are purchasing a vehicle the loan term would generally be up to five years, however, if you are purchasing property the loan term is commonly 25-30 years. You may be able to afford paying off a vehicle over 30 years, however, this would not be appropriate if the life of the vehicle is only five years.

Interest rates will affect the loan repayment and this is often the main variable that banks advertise. It is something that the banks will negotiate based on your strength or risk as a customer. Credit history, along with the loan security will be considered by the bank when negotiating this rate.

Loan Security

When applying for a business loan, the security you have or asset behind the loan will impact firstly whether the bank will give you the loan, and then secondly, the interest rate they are charging as part of the loan.

When assessing the risk of the loan, the bank will want to see what they can secure the loan with. This is basically what they can draw on should you not pay your loan.

For example if you have a car and you don’t pay your car loan, it is easy for them to repossess the car and sell it at auction to pay off the loan. In this example the car would be considered the security for the loan.

two business men shaking handsUnsecured vs Secured Lending

As discussed above, an asset may be offered as direct security for a loan and this will reduce the bank’s risk and the interest rate you pay on your loan. When applying for a business loan, you can also apply for an unsecured loan. This basically means that the bank is not taking a direct charge over an asset but will rely on your business goodwill or trading history to support the loan. You can pay a significantly higher interest rate as a penalty for an unsecured loan, so business owners should consider the loan cost before applying for an unsecured loan.

With secured lending, another way to drop the interest rate is to reduce the loan amount against the secured asset. For example if you have an asset worth $50,000 and only borrow $40,000, then you are only borrowing 80% of the value of the asset. This is called the ‘loan-to-value’ ratio (LVR) and reducing the LVR can make your loan significantly cheaper.

With business lending, the other way banks can reduce the risk is for the directors of the business to provide a personal guarantee. If the business doesn’t have much in the way of assets but the directors personally have many assets, then a personal guarantee gives the bank a lower risk on the loan. Once again if you are not specifically providing an asset as direct security, this could still be classified as an ‘unsecured loan’ because the bank doesn’t have a specific asset that they can sell if you default on the loan. So, while it may help reduce your interest rate it may not be a large saving. Directors need to be very careful when providing personal guarantees and should always consult professional advice prior, as these go beyond the protections involved with liquidation of businesses and could make business owners personally liable.

woman completing paperworkInterest Rates: Fixed or Variable?

Another consideration when applying for a business loan is whether to fix an interest rate or leave it variable. As most of us would have experienced, when the Reserve Bank of Australia increases an interest rate the banks inevitably increase their variable lending rate. This will then adjust your loan repayment to ensure it is paid off within the loan term. Fixed rate lending is usually offered on equipment finance and repayments do not change over the term of the loan. Both can have advantages and disadvantages and there is no right or wrong here; it is just an additional consideration of the risks involved with interest rates increasing to ensure you will still be able to service the loan.

Commercial Lending is More Risky than Personal Lending

In Australia, lending is generally considered more risky when lending as a business. Business owners should be careful when seeking loans from sub-prime lenders. This is because personally, we have the protections of Australian Consumer Law, and most people have heard of the ‘Australian Competition and Consumer Commission’, or the ACCC as it’s commonly referred to. So, when applying for business loans be aware that the lender has fewer restrictions and less of an obligation when offering you a loan. At face value, the loan may look okay, but the fine print can give them the ability to increase interest rates for all sorts of reasons.

business woman meeting with coupleTips for a Successful Business Loan Application

Whether you’re the director of a large business, or you’re wondering how to apply for a small business loan, there are a few additional considerations. Apart from the obvious warning of watching out for hidden fees associated with your loan, you should always consider what will be the cheapest form of finance with what you have available. The following are some of the pointers I give clients when applying for a business loan:

  1. Shop around and always get a quote from other lenders such as your major business bank, as they are often the most responsible and best value. Second tier lenders have a purpose, but are often going to have less favourable terms (like in Joe’s example above!)
  2. If possible, use secured finance to reduce the interest rate. If you require funding for unsecured cash flow purposes, perhaps you can find something tangible you can offer as security such as equipment to keep the interest rate down.
  3. See if you can get a discount for providing a deposit toward the finance to reduce the risk for the lender.
  4. Never push finance right to the limit. If banks do not want to lend to you, then don’t take it personally. Try to understand if you are lacking in serviceability; it is better not to take the loan than not be able to repay it.
  5. Remember that brokers and banks are being paid to get you the loan which is potentially a conflict of interest, so it is always best to talk to an independent source like your accountant.

Where to from Here?

If you’re looking for advice on how to apply for a business loan or how to apply for a small business loan, then getting professional financial advice is a smart course of action. The team at Bishop Collins are experts in every aspect of business accounting and provide solutions to protect your assets and assist you with minimising the financial risk to your business.

Please reach out to us at Bishop Collins if you would like to seek professional advice on how to apply for a business loan.

Bookkeeping Business Coaching

Managing Your Australian Business Number (ABN)

woman at work desk

Glenn Harris

Glenn Harris

Director

While there is a limitless amount of preparation required to start running your own business, there are some critical basic matters you need to attend to regarding your tax compliance and related matters. One of the key components to operating a business in Australia is an Australian Business Number.

The Rewards of Running Your Own Business

Creating, building, and running a small business is equal parts rewarding and challenging. There is a lot of personal satisfaction to be gained from nurturing your business and seeing it grow and the opportunity it provides your family, employees and other stakeholders connected to your business.

It provides you the freedom to be your own boss and make decisions which you believe are appropriate for your given field of expertise. It will allow you to build wealth and create something of value you can pass onto the next generation or sell for a financially comfortable retirement.

two pairs feet motivational pavement signWhat is an Australian Business Number?

One of the key components to owning and running a business in Australia is an Australian Business Number (ABN), which you’ll need to apply for. This is a unique 11-digit number which allows the government and other businesses to identify who you and your business are.

Not everyone is entitled to an Australian Business Number. To be entitled to an ABN you need to be operating in Australia. You must have started trading or have commenced business-like activities towards the commencement of business-like trading activities.

If your activities are a hobby or you are an employee, you will not be entitled to an ABN for these activities.

Your Australian Business Number does not replace your Tax File Number (TFN). Your business will need both numbers unless you conduct your business as a sole trader and then you will use your personal TFN.

Regardless of your legal business structure, the requirements for an ABN will be similar. These legal structures may include sole trader, partnership, trust, superannuation fund or company.

It is illegal to apply for an Australian Business Number if you are not entitled to one. Penalties of up to $10,200 may apply for each false and misleading statement made in connection with an ABN application.

An Australian Business Number doesn’t replace an Australian Company Number (ACN). An ACN is a unique number issued by the Australian Securities & Investments Commission (ASIC) when you incorporate a new company.

business owner holding open signWhy Do I Need an ABN?

When running a business in Australia it is critical to have an Australian Business Number. You will use your ABN to:

  • Avoid having customers withhold payments made to you**
  • Register for Goods & Services Tax (GST)
  • Other business registrations including (PAYG) withholding and Fringe Benefits Tax
  • Identify your business with customers and suppliers

** “The non-ABN withholding rule” – If you supply services to another business, with a value greater than $75, and you do not provide your ABN, the customer is required to withhold tax at the top marginal rate from the payment to you. This rate is 47% from 1 July 2017. Where an amount is withheld under this rule the withheld amount is reported on the customers next business activity statement. The withholder is then required to provide you with a statement confirming the withheld amount so you can claim the appropriate tax credit.

Applying for an ABN

You can apply for an Australian Business Number at the Australian Government Business Registration services website.

Make sure that when you go to apply, you have the following information on hand to complete the application:

  • Details of your business structure
  • Proof of Identity
  • Details of your business operations i.e. industry type etc

You will generally receive your ABN immediately on completion of the application, assuming you were properly identified. If more information is required to complete the application the ATO will generally contact you within 20 business days.

three colleagues laughing informal meetingHow Long Does an ABN Remain Active?

Your Australian Business Number will remain active as long as you are operating your business. If you cease operating your business, you will need to cancel your ABN as you are no longer entitled to hold an ABN. The ATO does periodically check in to determine if you are still carrying on a business. This review by the ATO will be more likely to occur where you fall behind with your Business Activity Statement (BAS) and income tax return lodgements.

How to Cancel an ABN

You can cancel your Australian Business Number if you are no longer carrying on a business in Australia by contacting the ATO. Some examples of why you would need to cancel your ABN include:

  • Your business has been sold
  • Your business has closed down
  • Your Business is no longer operating in Australia

Before you cancel your ABN, you need to ensure all of your connected registrations lodgements are up to date and also cancelled with the ATO including:

  • GST
  • PAYG (withholding)
  • Single Touch Payroll
  • FBT

How to Reactivate an ABN

Once you cancel your Australian Business Number, you are unable to simply “reactivate” it. You will need to re-apply for an ABN should you require one again in the future. In this case, you should include your old ABN in the application when asked to do so.

person searching australian business number on laptop

Where Do I Find a Business’s ABN?

You can search for an Australian Business Number for another business you deal with on the ABN Lookup service. This is a free public view of the Australian Business Register. You can also use this service to update your own ABN details. In this current environment it is critical you keep your ABN details up to date as many agencies across all levels of government rely on the ABN information to identify your business and provide services.

Get Professional Help on ABNs

A registered tax agent can support you and provide any help you require in connection with your Australian Business Number and your dealings with the Tax Office.

Should you require any help in connection with your ABN please do not hesitate to reach out to us at Bishop Collins and our friendly and professional team will be happy to assist you.

Audit & Assurance

Why do I Need an Internal Business Audit?

The difference between an Internal Audit and External Audit is not always clearly understood. Both internal and external audits are completed with a high degree of independence, diligence and ethics, however, there are key differences in the essential elements of these audits, including purpose and objectives, focus, reporting and outcomes.

What are Internal and External Audits?

Firstly, let’s have a brief refresher on the distinction between internal and external audits.

External Audits

Many businesses and organisations are required to prepare financial information for stakeholders. This is achieved by preparing financial statements. The purpose of financial statements is to provide information about the results of a company’s operations, its financial position, and its cash flows. This information provides transparency and accountability of management’s stewardship of the organisation’s resources to these stakeholders.

Accompanying the financial report is the audit opinion, which is the independent evaluation of the financial report of an organisation. Therefore the purpose of an external audit is “to enhance confidence for intended users in the financial report”. These users might be shareholders, members, lenders, or other stakeholders. You can read more about external audits here.

two business woman discussing internal auditInternal Audits

An internal audit on the other hand, is primarily focused on helping an organisation improve and helping to achieve your business objectives while managing risk.  An internal business audit is beneficial to evaluate and improve the effectiveness of risk management, control and governance processes. Our internal auditors work with you to review systems and operations. These internal business audits, or reviews, are aimed at identifying how well risks are managed including whether the right processes are in place, and whether agreed procedures are being adhered to. Internal audits also identify areas where improvements and efficiencies might be achieved. You can read more about the “flavours” of internal audit here.

The Role of the Auditor in Internal and External Audits

The role of the auditor vastly differs between internal and external audits. External auditors focus on the accuracy of the annual report and financial statements, whereas the internal auditor has a surprisingly broad mandate which considers anything which might be important to an organisation’s success.

Attributes of Internal and External Audits

We’ve assembled this overview to assist in understanding the differences between the attributes of internal and external audits.

Attribute Internal Audit External Audit
Appointment Outsourced provider or designated employee or function within an organisation Appointed externally (e.g. via shareholders (if a public company) or members
Independence Independent of activities subject to internal audit scope and management Independent of the governing body and management.
Reports to The audit committee (if established) or the board of directors (or committee members) Shareholders, members and the board of directors (or committee members)
Objective Varies according to the internal audit scope. Importantly the focus is on evaluating controls to facilitate an organisation achieving its goals and objectives. Forming an opinion on the financial report of the organisation.
Focus Forward-looking Historical
Fraud May be directly concerned with the prevention of fraud in any activity reviewed Directly concerned when financial statements may be materially affected by fraud. Incidentally concerned with  prevention and detection of fraud.
Outcome Assists an organisation enhance and protect

organisation value and accomplish objectives.

Opinion on financial statements

open plan officeWhy do you Need an Internal Audit?

In a nutshell, internal business audits help evaluate and improve the effectiveness of risk management, control and governance processes. For example, internal audits can look at and assist in the following review areas:

  • Ensuring your accounting processes are efficient and effective,
  • Identifying, understanding and managing high risk areas,
  • Ensuring compliance with policies, procedures, laws and regulations,
  • Streamlining operations,
  • Safeguarding assets and ensuring efficient use of resources,
  • Achieving strategic and operational objectives and goals,
  • Ensuring governance and risk assessment processes are in line with best practice,
  • Preventing and detecting fraud; Take a sneaky peek at our article on fraud exposures here, and download our tips to prevent fraud here.

As is indicated above, internal auditors work across all areas of an organisation and provide independent audit reports to the audit committee or Board. Auditors go beyond statutory compliance and aim to provide insight into multiple areas of your business beyond financial controls and transactions. Whether it be IT, operations (e.g. production, supply chain, environmental, human resources etc.), as well as intangible elements such as culture and ethics. Frankly, any system or protocol that has an impact on the efficient and effective operation of an organisation could be subject to internal audit and included in the internal audit plan.

business women conducting internal auditThe Relationship Between Internal and External Auditors

At times, the work performed by a company’s internal audit function can overlap with the work conducted by the external auditor. This includes, for example, specific financial review areas such as expenditure, revenue and the like, or areas dealing with the assessment of control processes such as their design, implementation and operational effectiveness. Accordingly, an opportunity presents itself whereby the external auditor, rather than duplicating these procedures, may be able to place reliance on the work carried out by the internal auditor.

Having a cohesive working relationship between the internal and external auditors may provide the following benefits:

  • Strengthened relationship between the external and internal auditors through a more effective dialogue. This also promotes efficiencies within the organisation subject to audit (e.g. not having to cover the same ground with two separate functions etc.),
  • The external auditor can gain additional insights into the entity leveraging from the experience and knowledge of the internal auditor,
  • The external auditor can use internal auditors who may have relevant expertise in particular areas,
  • The external audit team can focus on the more significant audit issues.

internal audit processHow an Internal Audit is Delivered

Internal auditors work in all sectors, be it public, private or not-for-profit. Depending on the size of your organisation, the internal audit function could be properly internal (e.g. with an in-house employee or team fulfilling this role) or through an external service provider. Common factors considered by organisations in making a decision on how to implement and deliver an internal audit function are:

  • Independence of the auditors,
  • Expertise of the auditors (e.g. experience with similar organisations, fields or skill sets),
  • In relation to the organisation:
    • Geographic spread
    • Nature of business
    • Technology,
  • Budget for internal audit function.

Some organisations adopt a hybrid internal business audit model, also known as ‘co-sourcing’. Co-sourcing allows an organisation to rely on the expertise of a professional auditing firm while still participating to the extent that your in-house team is able. For some organisations, the need for a co-sourced internal audit team is needed to address specific and complex issues or to perform a highly specialised review area. This model can be incredibly efficient as it allows resources to be directed to other areas of the organisation, allows access to specialised expertise and potentially promotes cost savings.

two men shaking handsWhere to from Here?

If you would like to discuss your organisation’s internal business audit requirements, the establishment of an internal audit function or facilitating the outsourcing (or co-sourcing) of your internal audit function, the team at Bishop Collins would be delighted to have an obligation-free and confidential discussion.
Please reach out to us at Bishop Collins if you would like to seek professional help to explore your internal audit options.

Taxation & Tax Tips

How to Declare Cash Income In Australia

piggy bank coins

Juston Jirwander

Juston Jirwander

Director

Cash and the Modern Economy

In the post-COVID world and with the rise of smart technology, cash is becoming a rare sight so it can be easy to forget how to declare cash income in Australia. We’re using less and less cash everyday, however there was a time we used cash every day – even if these days seem like ancient history! One thing has been the same over a long period, though; we rarely use or see hundred dollar bills! The thing is, these account for mountains of cash! So, where is all this money?

According to the Reserve Bank of Australia (RBA) in their discussion paper titled The Life of Banknotes (2015), there are 300 million $100 notes in circulation. To put it in perspective, that’s almost three times the number of $5 notes! There’s a reason you never see $100 bank notes. The RBA thinks they are literally “stuffed under the mattress” as an alternative to banks with some portion kept overseas for tourists. It is thought only 25% are in general circulation.

While they are often hidden as a store of wealth, another less virtuous reason is that they are being used for Tax Avoidance purposes or for criminal activities.

Let’s deal with the issue of Tax Avoidance first then move to how to declare cash income as they are closely linked.

I’m often asked whether it is better to accept cash money and keep it “under the mattress” rather than deposit it into a bank account. The reason stems from thinking this is tax free. Let’s be clear: it is not tax free! Not declaring cash income in Australia is against the law.

The ability to use this cash has significantly reduced as less and less people use or want cash payments. COVID has accelerated this change.

There are two main factors which I believe are eliminating the need for cash and therefore the cash economy, which is also known as the shadow economy: efficient use of technology and cultural changes.

EFTPOS transaction

Efficient Use of Technology

The efficient use of technology has two key effects on cash and its use in the shadow economy.

Convenience

Technology makes it more efficient to use digital means of payment. I can’t remember the last time I preferred to pay with cash rather than “Tap and Go”? I don’t even want the receipt anymore because I have that record on my phone unless it is a deductible expense and I want a compliant tax invoice.

Compliance and Policing

The Australian Taxation Office (ATO) uses very sophisticated data matching analysis and forensic capabilities, making cash payments more visible. For example, the ATO can identify people who may be running a part of their normal business activities off the books and avoiding their obligations.

To keep it fair for the majority of businesses that do the right thing, the ATO deals with those who try to operate outside the tax system firmly. With a significant increase to funding in the latest budget, the ATO’s tax avoidance taskforce aims to raise $3.7 Billion over 4 years from the shadow economy and personal income tax, while the Multinational tax integrity package will aim to raise $1 Billion over four years from large multinational entities.

NOTE:  We recommend all our clients to consider ATO Audit Insurance as this can save considerable pain if the ATO decides to audit your affairs.

woman purchasing goods with phone pay

Cultural Changes

Technology is used more widely by Generation Z (those born between 1997 and 2012) who grew up in the digital age, as well as Millennials (those born between 1980 and 1997) who saw the most rapid technology advancements. Generation X (those born between 1965 and 1980) remember an analog life but have no problem adapting to digital services. Even the Baby Boomers (those born before 1965) are willing to adopt digital methods of payment provided it is more convenient and adds value.

More secure digital banking and payment platforms provide not only security but also flexibility and convenience.

So, now I have shared my opinion, let’s look at how to declare cash income in Australia.

How to Declare Cash Income in Australia

Receiving Cash for Work You Do

Your employer may pay your wages to you in cash (or with a cash cheque), rather than into your bank account. Paying wages in cash is legal and may be more convenient.

However, some businesses deliberately use cash transactions (for example, pay their employees ‘cash-in-hand’) to avoid meeting their tax and employee responsibilities. This is not legal and they will eventually get caught.

If your employer is paying you cash make sure to consider the following:

  • You must declare any cash you receive as income when you lodge your tax return
  • You should get a payslip showing your earnings and the tax your employer takes out
  • At the end of the year you should also get an income statement that shows your full earnings and the amount of tax your employer has taken out for the full year
  • Make sure that your employer is making super contributions
  • Check that your employer is taking the correct amount of tax out of your pay – this helps to make sure you don’t end up with a large tax bill at the end of the year. Click here to utilise the ATO Tax Calculator.

woman writing in book

Declare Your Tips

Cash tips are income and not excluded from tax, regardless of how you receive them. It makes no difference if tips come from your employer or direct from customers.

If you receive cash tips, you must declare these as cash income in your tax return at “Allowances, earnings, tips, directors fees etc”. Not declaring cash income in Australia, including tips, makes you liable for interest charges and penalties as well as the undeclared income tax.

Receiving Business Cash Income

Your clients may wish to pay cash, so if your business receives cash payments for goods or services, it must be declared as cash income.

Something you may be unaware of is that the business must also include:

  • Income earned through coupons, vouchers or gift cards,
  • Income deposited into a mortgage or private credit card instead of the businesses trading account.

busking musician

The Future

When you see buskers using QR codes to receive appreciation donations, I believe that’s a sign that in the medium term, perhaps five to ten years’ time, physical cash will be very rare and may even cease to exist. So get those $100 bills out of the mattress and either start spending or put it in your account!

In the meantime, if you have any questions or concerns about whether your utilisation of cash is legal, or how to declare cash income in Australia, then don’t hesitate to get in touch with the team here at Bishop Collins. Our team of professional accountants and finance experts know the legalities of tax and money inside and out, and can assist you in ensuring you’re compliant.

Happy cashless day to you all!

Audit & Assurance

What are General Purpose Financial Statements?

general purpose financial statement

It’s the nature of being in business that many companies and organisations have the requirement to prepare and provide their financial information to stakeholders. Financial statements are how they do this. Financial statements provide stakeholders with information covering the results of company operations, the company’s financial position, and details of its cash flow. This information offers stakeholders transparency and provides accountability of the company’s senior management. An example of stakeholders who would receive such financial statements include shareholders, members, lenders or others.

Because there can often be many recipients of financial statements, each with different tailored information needs, there is a need for a broad range of financial information required in a set of financial statements. The solution is to prepare a ‘general purpose financial report’ (“GPFR”) also called ‘general purpose financial statements’ (“GPFS”) in order to present relevant information to stakeholders. Australian Accounting Standards stipulate what information a GPFS must disclose and how it is presented.

General purpose financial statements are defined in “AASB 101 Presentation of Financial Statements” as “those intended to meet the needs of users who are not in a position to require an entity to prepare reports tailored to their particular information needs”, and needs to comply with the requirements of all applicable Australian Accounting standards.

women comparing financial statements

The Difference Between Special Purpose and General Purpose Financial Statements

The financial statements are prepared for general users, which means users who can’t directly ask for information from a business or organisation. The business prepares statements to be materiality correct and focus on what is important to their general users and stakeholders. For this reason, general purpose financial statements are standardised.

On the flipside, we have “special purpose financial statements” (“SPFS”). These are financial reports created to present financial information to specific stakeholders. In many cases, unlike the stakeholders who GPFS’s are prepared for, the stakeholders of a SPFS are in a position to command and tailor the information to satisfy their requirements, for example, owners and directors who have a direct operational stake in an organisation. Special purpose financial statements provide many small and medium-sized businesses access to greater informational flexibility. This is because the statements are often presented in a simpler format. The rules for reporting that have been established by an organisation’s directors, owners, or members are often adhered to by this straightforward financial report.

There have recently been some changes to the requirements to provide a SPFS. From 1st July 2022, special purpose financial statements will no longer be required in Australia for certain kinds of for-profit private sector enterprises. The majority of organisations that will be impacted are those in the private sector that operate for profit and are required to lodge financial statements with the Australian Securities and Investments Commission (ASIC). These entities will not be allowed to prepare and lodge SPFS for years ending on 30 June 2022.  

woman writing notepad

What Information Should General Purpose Financial Statements Provide?

A GPFS prepared in accordance with Australian Accounting Standards should provide a structured representation of the financial position, financial performance and cash flows of a business or organisation. It should provide information that is useful to a wide range of stakeholders that assist them in making economic decisions. It should also show the results of how the organisation’s management have performed and utilised the resources entrusted to it. To meet this objective, financial statements provide information about an organsiation’s:

  • assets;
  • liabilities;
  • equity;
  • income and expenses, including gains and losses;
  • contributions by and distributions to owners in their capacity as owners; and
  • cash flows.

This information, along with additional information in the notes, assists the stakeholders who use the financial statements in predicting the organisation’s future cash flow and, in particular, their timing and accuracy.

A complete set of financial statements comprises:

  • a statement of financial position as at the end of the period;
  • a statement of profit or loss and other comprehensive income for the period;
  • a statement of changes in equity for the period;
  • a statement of cash flows for the period;
  • notes, comprising significant accounting policies and other explanatory information; and
  • comparative information in respect of the preceding period

business team finance meeting

What is a Simplified Disclosure Framework?

Your business, organisation or charity can choose to prepare full General Purpose Financial Statements (Tier 1), or General Purpose Financial Statements under a simplified disclosure framework (Tier 2).

If you choose to prepare a GPFS with a simplified disclosure framework, the statements are still considered to be General Purpose Financial Statements. However the key distinction is the eligibility to provide fewer, uncomplicated disclosures.

There were some changes to the disclosure standard recently. The new simplified disclosure standard replaces the former Tier 2 Reduced Disclosure Requirements (RDR) framework, from 1 July 2021. The changes have been introduced as part of AASB 1060 General Purpose Financial Statements – Simplified Disclosures for For-Profit and Not-for-Profit Tier 2 Entities. Under AASB 1060, all relevant disclosure requirements are contained in a single standard. The changes will apply to all Tier 2 entities and do not affect which entities are permitted to apply Tier 2. The recognition and measurement requirements of Tier 2 also remain unchanged and the same as Tier 1. For more information about the changes and the new disclosures that will be required, refer to AASB 1060 on the AASB website (www.aasb.gov.au).

The Experts are Here to Help!

Remember, the need to prepare general purpose financial statements or special purpose financial statements may also require you to have these audited. Take a peek at our article on whether you need to have an audit completed on your financial statements here.

If you would like to discuss your organisation’s requirements to prepare general purpose financial statements the accounting experts at Bishop Collins would be delighted to have an obligation-free and confidential discussion with you. Please reach out to us if you would like to seek professional help with General Purpose Financial Statements.

Bookkeeping

A Practical Guide to Single Touch Payroll Phase 2

person doing single touch payroll laptop

Tim Ricardo Company Director on Bishop Collins

Tim Ricardo

Director

For many employers, it’s been months since the implementation of Single Touch Payroll Phase 2, however for many businesses who use Xero this has only just started to come onto the radar. The Single Touch Payroll (STP) Phase 2 deadline was initially 1 January 2022. Xero, being one of the largest small business payroll providers, was given a 12 month extension to 1 January 2023.

What is Single Touch Payroll?

A few years ago, businesses were required to start reporting certain information to the ATO. This included Gross Pay, Allowances, Superannuation and Tax Withheld. At the time this was a gigantic leap and probably the largest change in payroll reporting in the history of Australia. The fact that at any given time the ATO knows exactly what every single worker in Australia is being paid in real time is enormous! The conspiracy theorists and tin-foil hatters were on high alert and anyone would agree that the government was spoiled with their new pool of information, with ATO Auditors ready to dive in and have a swim around. Most parents could have predicted that spoiling anyone never satisfies and so sure enough, a few years later we found ourselves staring down the barrel of STP Phase 2.

What is Single Touch Payroll Phase 2?

In a nutshell, Single Touch Payroll Phase 2 provides more information to the ATO in your regular STP lodgement. So, employers will need to take extra care in their payroll lodgements to make sure that each pay is correctly broken down for each employee. The ATO website suggests that STP2 “will reduce reporting burden for employers who need to report information about their employees to multiple government agencies”. This statement may be true but the elephant in the room is that it will no-doubt increase the reporting burden for every business in their payroll reporting.

Let’s imagine you work at a desk on the tenth floor, but your desk is across the other side of the room. That means you can catch the elevator to the tenth floor, but would unfortunately have to walk 10 paces to your desk. Your boss has now removed access to the elevator but the stairs enter right next to your desk so it would be true for your boss to say that for those employees who had to walk 10 paces to their desk we have reduced this burden and ‘streamlined’ your desk access once arriving at our floor.  Without wanting to sound too critical, exercise is good for any individual and likewise, businesses should also take the time to make sure their employees are all being paid properly.

So let’s break down what information is going to be added to reporting in Single Touch Payroll Phase 2. While I’ve aimed to make this article as informative as possible, the ATO goes into more detail about what each of these categories are here.

employee customer interaction

Income Types

Your payroll software should break down the income types which need to be taxed differently. There will be a code used to differentiate what category of payment you are receiving.  A few examples of these are:

  • SAW (salary and wages): This is the standard that captures the bulk of employees
  • CHP (closely held payees): This covers some small business related payees who have certain exemptions that allow them to lodge once per quarter instead of every payrun.
  • WHM (working holiday makers): This covers workers under 417 or 462 visas. Farmers will often use these.

Disaggregation of Gross

As mentioned above, businesses are already providing the gross payment in their regular STP lodgement. The first part of Single Touch Payroll Phase 2 will be breaking up this gross payment and the ATO have labelled this the ‘disaggregation of gross’. Once you have setup your payroll accordingly the ATO will be receiving the following:

  • Gross
  • Paid Leave
  • Allowances
  • Bonuses and commissions
  • Directors fees
  • Lump sum
  • Salary Sacrifice

Employment Taxing Conditions

Previously you would keep records when commencing and ending an employee’s engagement. The most obvious change is that previously you would lodge a ‘TFN declaration’ (generally electronically) to the ATO. Instead of doing this as a separate task this will be sent within the STP2 information. You will still need to get the employee to fill one of these in when you employ them however it will not need to be lodged separately.

Information for Single Touch Payroll Phase 2 includes:

  • Employment basis, i.e. casual, part-time, permanent
  • What withholding is required for each employee, e.g. tax free threshold, HECS/HELP and Student loans.
  • Details of when and why an employee leaves

Child Support Garnishes and Deductions

This is one of the instances which may reduce reporting with Child Support however it is an optional feature.

business person checks stp reporting data laptop

What do I Need to do to be Compliant with Single Touch Payroll Phase 2?

This will depend on your payroll digital service provider. Some employers are already reporting through Single Touch Payroll Phase 2 however, I have many businesses on Xero and these are facing this for the first time. For those lodging through Xero you have until the 31st December 2022 to update your pay items and check your payroll setup to be compliant with STP2. As per usual, Xero has done a good job of trying to simplify this process and once you go into the Single Touch Payroll under the menu you can go to the STP2 menu and follow through the steps.

After updating the employees, the next step is to update the pay items. As mentioned this is part of the “disaggregation of gross” discussed earlier. At this step it starts getting a bit complicated and is what triggered my writing of this article. Most instructions don’t go into detail of what is required here. Every employee comes under an award and most employers, when setting up their employee, should look up the award and make sure their employees are being paid the minimum rate of pay. The problem is that most employers don’t usually go through and break down what that pay is made up of and this could cause a problem with this step for most employers that manage their own payroll.

Small business owners generally don’t have a payroll department and although they might check they are paying the minimum wage, they will often just set their pays for themselves and their employees above the minimum rate so there doesn’t need to be constant adjustments. This eases their administrative burden.

builder apprentice on site

Let’s take a look at an example:

Luke is a builder and is just paying wages for him and an apprentice.

Luke will go onto the fair work calculator (known as the P.A.C.T) to help find the rate of his and his apprentice’s pay, which can be found here.

He has decided that he is under the Building and Construction Award as a Level 8 Construction Worker and supervises 1 Level 3 Construction Worker. This means that his minimum gross hourly rate is $31.26. This includes ‘all purpose allowances’ as follows:

  • Industry allowance $1.19 per hour
  • Leading hand allowance $0.68 per hour
  • Tool allowance $0.92 per hour

Luke, however, has set his pay at $40 per hour. Previously, we would just set his hourly rate as $40 in his payroll system and that would be the end of it.

Now, under Single Touch Payroll Phase 2, Luke will need to change his setup to separate the ‘all purpose allowances’ and his remaining gross pay so it can be submitted properly and in accordance with STP 2.

Luke will need to keep an eye on the minimum pay rates because every time they go up, he will need to change his pay template for each of his staff to make sure he is paying over the minimum allowances in accordance with the award. Otherwise, his employee could complain to Fair Work Australia and he may need to pay the shortfall. Presently, I am unsure if the ATO will be sharing this information with Fair Work Australia, however, employers should take care to not submit incorrect pay breakdown information or this may cause problems in an employee dispute.

For illustration here would be a snippet of the base weekly pay from a xero payrun:table

While trying to keep ahead of the administrative burden, Luke may decide to set up his pay with his ‘all purpose allowances’ set at amounts well over the award and balance his $40 per hour in the ordinary hours section by deducting the allowance rates.

As you can see, for employers to go through this process for each of their employees is time consuming. I can appreciate that to do this properly is a challenging prospect depending on the award your employees are under.

couple meeting accountant

Super Guarantee is still a Focus of Single Touch Payroll

One of the underlying compliance purposes of Single Touch Payroll is to ensure that super is paid on the correct pay items and the ATO will continue to monitor super payments and reported wages to make sure that employers are paying the correct amounts of super.

Employers will have to carefully work through and correctly classify overtime and overtime allowances because super guarantee is not payable on overtime, so be sure the overtime is in accordance with your employer obligations.

When to Seek Professional Help

There are two main issues that need to be dealt with here:

Firstly, there is the human resource (HR) component. If you are unsure about your employee awards or interpreting these correctly you may need to obtain professional HR support. We are seeing a rise in HR service offerings and this may be yet another push away from self-managing your HR. The good news is that there are now low-cost options for most employers and they can get some legal guidance under a per employee subscription that doesn’t break the bank.

Secondly, once you know your award and minimum pays you need to ensure that you are reporting things correctly. This is where your accountant and bookkeeper come in. We are seeing a number of businesses who know they are paying the correct rates however, need to make sure they are set up correctly through their payroll provider. The cost here will vary depending on how many employees you have and the complexity of the award.

Please reach out to us at Bishop Collins if you would like to seek professional help to update your payroll reporting.

Taxation & Tax Tips

How to Make Your Profit and Loss Statement (P&L) Work for You

woman and man having finance meeting

Juston Jirwander

Juston Jirwander

Director

“We were always focused on our profit and loss statement, but cash flow was not a regularly discussed topic. It was as if we were driving along, watching only the speedometer, when in fact we were running out of gas.”

Michael Dell, Founder and CEO of DELL Computers.

“The substance of the eminent Socialist gentlemen’s speech is that making a profit is a sin. It is my belief that the real sin is taking a loss!” 

Winston Churchill

These quotes from a couple of pertinent figures are the ideal starting point to provide stimulus for the discussion of your profit and loss statement, and how your P&L can work for you and keep your business profitable.

two women working laptop

What is a Profit and Loss Statement?

A profit and loss statement can help you pinpoint areas of success as well as spots where your business may need additional help such as cash flow management. A P&L is made up of various elements that depend on the nature of the activity that your business or organisation undertakes.

The best starting point for discussing the elements of a Profit and Loss statement, is to choose a time period to review, for example 1 July 21 to 30 June 22.

Revenue

The first and most important element is total revenue.

Here’s an example; Jim runs a B2B company that sells computers, and invoices $1,000,000 for the year. He only receives $900,000 in cash for that same period and is still owed $100,000. His “Total Revenue” under a “Cash Basis” is $900,000 but on an accruals basis is $1,000,000.

All Profit and Loss statements use accruals and this can cause business owners confusion when they compare the P&L to their cash flow. Remember this, because we will discuss this later in the article.

We can use this information to work for us such as comparing revenue to :

  • Previous years, which can tell us if we are growing or contracting in our sales.
  • Various periods during the year to determine which periods are our busiest periods and which are our quietest so we can plan our year ahead.  Quiet times are good for staff to have holidays and when we may need more finance. Busy periods are when we will have more cash and when we will need resources more available, so we have products to sell or staff to complete the task.

australian hundred dollar bills

COGS: Cost of Goods Sold

The second element of the profit and loss statement does not apply to all businesses or organisations. The “Cost Of Goods Sold”, or COGS, refers to the value of the stock that is sold. Businesses that provide a service do not sell products and therefore have no stock. This means they will not have a COGS element in their P&L.

Here’s an example; Jims Computer’s COGS is calculated by what has been sold, not what he has purchased during that period. Jim has opening stock of $100,000 and closing stock of $200,000. During the year he purchased $600,000 of computer equipment. So he has sold the opening stock plus the purchases during the period, less what he has not yet sold:

$100,000 + $600,000 – $200,000 = $500,000.

Gross Profit

The third element is the “Total Revenue”, less the “COGS” which gives us the “Gross Profit”.

It is here that we can get more useful data such as the margin we are making on our product sales. This “Gross Profit Margin” (calculated as the Gross Profit / Total Revenue) tells us how we compare to industry average, to our competitors (especially public companies that must publish their data) or to best practices. It can tell us if we may be undercharging or overcharging our customers. We can also test the effects on sales if we increase or reduce our prices and if this helps overall profitability.

cafe baristas working

Operating Expenses

The fourth element of the profit and loss statement is the “Total Operating Expenses”. This includes all your operating costs such as rent, wages, insurance, electricity, travel, interest and depreciation among other things.

Again, this data can work for us by showing how we compare to the wider industry and how we compare period on period. For example, if our insurance costs have increased by 40% it may be time to test the market and get alternative quotes rather than paying the given increases.

Operating Profit and Loss

Our Operating P&L is calculated as “Gross Profit” less “Total Operating Expenses”. This is the second area of profitability that shows the profit or loss that has come from the operating activities.

There are additional elements to the profit and loss statement that you may have seen such as EBITDA or Earnings Before Interest Tax Depreciation and Amortisation which is used to calculate profitability without items regarded as coming from financing activities or investing activities. This is used to assist in valuing a company and we will not cover this in this paper.

happy woman checking laptop

More Ways a Profit and Loss Statement Can Work for You

Let’s be clear; a P&L statement is a snapshot of the revenue earned and the costs incurred for a given time period in the PAST. It is not a guarantee of the future.

Like all history lessons, it tells us about our past so we can do the following:

  • Predict the likely future if no change is made to operations
  • Allow us to review the past in order to see if we can make changes that will be favourable to future results
  • Compare changes we have made in past periods and their effectiveness on the latest period
  • Help us to determine our future forecast and set budgets into the future
  • And lastly, after everything above it can help us manage cash flow moving forward

man confused holding papers

My P&L Statement Says I’ve Made a Profit, but I Have No Cash. Help!

This is a common frustration we hear from growing businesses and organisations. The answer lies in two key areas that we’ll explore in this section.

1. Understanding the Profit and Loss Statement and the Balance Sheet

As we discussed earlier in this blog, the P&L statement is created using the accruals method of what you have earned and the costs you have incurred, not what money you have received or paid. So, if your P&L states you have a profit but you have no money in the bank then you need to turn to the other section of your financial accounts which is the balance sheet. The balance sheet will tell you where your profit sits. If your profit is not in cash, it will be in other areas such as an increase in assets from the previous period. These could include:

  • Accounts Receivable, i.e. businesses that owe you money
  • Fixed Assets you may have purchased, i.e. equipment, machinery, property etc
  • Loans to related parties such as Directors
  • Stock on hand

The other place your profit may have gone is into reducing your liabilities from the previous period such as:

  • Paying down bank loans
  • Reducing employee provisions such as Long Service Leave or Annual Leave
  • Reducing accounts payable

warehouse inventory

2. Demands of a Growing Business

The most frustrating issue for a growing business is seeing growing sales and growing profit but no money in the bank and creditors screaming for payment.

This is due to what we call “Working Capital”. Working capital is defined as the capital (or funds) of a business which are used in the day to day trading operations of the organisation. The most common elements of working capital are:

  • Inventory
  • Accounts receivable
  • Accounts payable and
  • Cash

When a business grows it needs to hold more inventory or stock on hand to be able to sell when there is demand. It will often need to provide credit terms as an incentive to gain more business, so the accounts receivable increases. If the business does not match the increased credit terms for its accounts payable, then cash becomes strained. For example, if the accounts payable terms are payments in 7 days but the business is providing accounts receivable at 45 days then the business will feel a cash flow crunch as it is effectively acting as a bank for its customers. As the business grows the strain on cash flow will get increasingly harder.

This may be okay if the business anticipates this and is strategically prepared by holding enough cash or debt to support the business while it is growing. If the extra terms are translating into more business without bad debts and the profitability is high, then this may be sustainable. There will however come a time when this needs to be balanced if profitability margins are small as capital availability is not limitless.

The management of cash flow and the strategic review of matching your accounts payable terms and your stock holding levels is critical. Poor cash flow management is one of the major causes of businesses failures.

business man woman high fiving

A Final Word About the Profit and Loss Statement

Having your profit and loss statement up to date for your business is vital as it’s one of the best reports to determine the financial health of your organisation. In addition, it is always demanded by future and current lenders, investors and the tax office.

Always seek an expert professional accountant to assist you in determining your organisation’s health. At Bishop Collins, our team knows that every business and its needs are different. We’re a dedicated, analytical, strategic and professional team, who also care about our clients. Our purpose is to make sure you feel your business and personal finances are in safe hands, so you are able to focus on the things you do best.  Get in touch with us today.

Taxation & Tax Tips

What Is Voluntary Redundancy and How Does It Work?

three business women meeting

Tim Ricardo Company Director on Bishop Collins

Tim Ricardo

Director

We’ve all heard of the industrial revolution, when mankind took that leap forward into machine manufacturing. Looking back we all agree this was a necessary step to advance our civilisation. However at the time it meant businesses had to reduce large parts of their workforce.

In many of these tragic circumstances employees were left without work as their skills were no longer in demand, so the only option was to, at their own cost, change their skill-set to find employment in different areas. These days, there are more protections for workers and opportunities to either be compensated or re-trained in new areas by their employers.

Downsizing is a difficult and stressful time for both employers and employees alike. For employers reducing their employees, there needs to be careful consideration of employment law, employee rights and also morale and productivity within what is left of your workforce. Getting it wrong can be costly for employers and so voluntary redundancy has become a useful strategy to consider when dealing with the messy business of downsizing.

What is Redundancy?

This is when an employer no longer requires an employee to fill their position. Most of us have heard examples of redundancy through innovation and technology changes however redundancy can occur for a number of reasons such as new processes, reduced demand for product, a business closing or simply a business relocating.

Under the National Employment Standards (NES) certain employers are required to offer compensation to employees when their position has become redundant. The amount of redundancy entitlements differ between the different industry awards. The entitlements generally consist of a number of weeks of pay and a number of weeks of notice depending on years of service.

Example: Standard Clerical Roles

If you have worked over 2 years the redundancy pay will be 6 weeks of pay with 2 weeks of notice.

For more information on your specific industry you can search on the Fair Work Australia website. 

two people shaking hands

What is Voluntary Redundancy?

Let’s take a look at what constitutes voluntary redundancy. When a business has excess staff and requires reduction in their labour force (for various reasons), they can approach employees to resign and in return offer a redundancy payment to the employee.

In this way the employee voluntarily accepts the redundancy rather than being forced by their employer. There are a number of up-sides to this because in these situations an employer is more protected from a claim against the employer. In return for accepting the financial payment they sign a legal document that protects the employer from any wrongdoing. There is also less hassle to the employer because they can offer redundancy to workers that may be retiring soon or are less satisfied with their job. This in turn can come across better for morale and helps with the remaining staff relationships.

As most employers know, not all employees are equal in their talent and work ethic. Most employers would be able to immediately identify their key staff and so they need to be careful in offering a blanket voluntary redundancy to all employees. If their key employees leave the business, they may be left in a worse situation than before the redundancy.

Who isn’t entitled to Redundancy?

There are a few categories of workers that Fair Work Australia excludes from being entitled to redundancy. These are employees:

  • with less than 12 months service
  • on contract for a specific period, task or season
  • terminated for serious misconduct
  • engaged as casual employees
  • as trainees under a trainee agreement and apprentices
  • under some Small Businesses

If a small business has less than 15 employees and under section 121 of Fair Work Australia Act 2009, they generally do not have to pay redundancy for their employees. There are a few awards that still require redundancy within a small business so check with Fair Work Australia if considering this as an option.

man working laptop

Genuine Redundancy and Taxes

Up until this point you might be thinking that it is the obvious choice to enact a voluntary redundancy, however when considering voluntary redundancy as an employee, you must also take into account the tax you would pay. It should be noted that if you leave voluntarily your redundancy may not be considered “Genuine”.

Any redundancy article would not be complete without looking at how redundancy works with regards to tax. Under Income Tax we generally will pay tax on wages, however when receiving a redundancy there is the possibility of receiving the payment tax free if it is a genuine redundancy.

A non-genuine redundancy occurs when, as an employee:

  • Your dismissal is because you reached retirement age
  • You’re at or over aged pension age on the day of dismissal
  • You leave voluntarily
  • Your leaving on termination of your contract
  • Your dismissal is for disciplinary or inefficiency reasons

A non-genuine redundancy is generally taxed at a lower rate than your normal income, however if the redundancy is genuine then the tax free threshold is currently $10,638 + ($5,320 x years of service).

To receive the payment tax free is a considerable benefit and should be considered when thinking of accepting a redundancy.

For more information on genuine redundancy, visit the Australian Taxation Office website.

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