Overview – Lisa’s Business
Meet Lisa, an ambitious entrepreneur who launched her business a few years ago. After dedicating years of hard work, she achieved remarkable success, generating a profit of $1 million in each of the last two financial years. However, this year she anticipated a drop in revenue, expecting her business to make less profit—and with it, she believed her tax obligations would decrease substantially.
Lisa’s business generated approximately $600,000 in profit this financial year. To her shock, however, the estimated tax payable was much higher than she expected. This led to a pressing concern: “How will I pay the tax when I don’t have the cash?”
At this point, we stepped in to conduct a cash flow analysis to understand why Lisa’s business appeared to lack the funds to meet her tax obligations, despite the reported profit.
Findings – Cash Flow Imbalance
Through the detailed cash flow analysis, we discovered that Lisa’s business did generate cash, but key decisions and commitments had restricted her ability to meet her tax obligations. Below are the critical findings:
- Pre-Booked Holidays and Non-Refundable Deposits
- Lisa had planned two holidays before this financial year, making deposits in advance. When the time arrived, she faced the decision of either forfeiting the deposits or going ahead with the trips. Given the non-refundable nature of the deposits, Lisa decided to proceed with the holidays, causing a notable cash outflow.
- Family-Related Business Opportunity
- Lisa’s father-in-law owned a business that operated from a leased warehouse. When the landlord decided to sell the property, Lisa’s husband saw an opportunity. As part of a longer-term plan to take over the family business, Lisa decided to support the purchase by providing an initial deposit of $400,000 from her business. While this was a strategic decision, it meant tying up significant cash that could have been used for other operational needs, including tax payments.
- Rising Interest Costs on Personal Property
- In addition to these business and family commitments, Lisa also owns a luxury home with a $2.5 million loan. Unfortunately, the fixed interest rate of 1.99% expired last year, and her mortgage has now reset to a 6.2% variable rate. The jump in interest payments placed additional financial strain on her cash flow, as her personal commitments became significantly more expensive.
Why Was the Tax Bill a Shock for Lisa, Even Though She Paid More Tax Last Year?
Lisa’s experience highlights a common pitfall many small businesses owners face: misunderstanding cash flow and tax obligations. Like many inexperienced business owners, Lisa treated the business’s profits as if they were her personal funds. Instead of planning for tax obligations, she spent the profits on personal indulgences and investments, believing the entire amount belonged to her. This led to the shock of an unexpected tax bill she was unprepared to pay.
Here’s a deeper look into what went wrong:
- Misguided Spending Decisions
- Lisa spent her profits on holidays and helped fund a property deposit, assuming that such expenses would be tax-deductible. Many new business owners fall into the trap of thinking that as long as they reinvest their profits into assets—like vehicles or properties—they can defer or reduce their tax obligations.
- However, capital asset purchases, like a property deposit, are not fully deductible in the year of purchase. In most cases, they are subject to capitalisation rules and depreciated over time. Lisa’s assumption that the deposit would immediately offset her tax obligations led her to overextend her cash flow.
- Mismanagement of Income Tax Instalments
- Lisa made another critical error by instructing her bookkeeper to reduce her income tax instalment to NIL. She believed that since her profit would be lower this year, there would be no tax liability. Unfortunately, she failed to realise that tax instalments are calculated based on profit, not cash flow, and any shortfall must be settled at the end of the financial year.
- This decision gave her a false sense of security, leaving her unprepared for the final tax bill. When the tax estimate arrived, she discovered she owed a substantial amount—despite thinking she had avoided it.
- Letting Go of Her Bookkeeper – A Costly Mistake
- As her cash flow tightened, Lisa decided to cut costs by letting go of her bookkeeper, thinking she could handle bookkeeping herself. Unfortunately, managing BAS (Business Activity Statements) and GST reporting requires expertise, and Lisa soon ran into trouble.
- She struggled to report BAS accurately and missed critical deadlines. Without proper bookkeeping, her records became disorganised, further complicating her tax reporting and creating additional stress. This led to delays in filing her GST returns, which not only increased her financial burden but also risked penalties from the Australian Taxation Office (ATO).
Lessons and Recommendations
Lisa’s case is a stark reminder that even a thriving business can face cash flow crises without proper financial management. Her missteps provide valuable insights and lessons for other small business owners. Below are the recommendations we provided to Lisa to help her regain financial stability and avoid similar issues in the future:
- Proactive Business Consulting with a Business Accountant
- Proactive meetings with a business accountant are crucial to avoiding costly mistakes and cash flow issues. While these meetings may involve upfront fees, we encourage business owners to see them as investments, not expenses. The strategic advice provided can prevent far greater financial challenges in the future. For Lisa, we recommended setting up quarterly meetings to stay ahead of her tax obligations. These sessions allow us to review profits, assess potential tax liabilities, and ensure cash reserves are properly allocated. Our proactive approach helps business owners make informed decisions, maintain financial stability, and support sustainable growth.
- Additionally, consulting with an accountant before making significant purchases—such as a property or other large asset—can help assess the impact on cash flow. Had Lisa sought advice before subsidising the property deposit from her business, she could have planned her cash flow better and avoided the shock of an unexpected tax bill.
- These consultations also help business owners stay aligned with changing tax laws and financial trends, allowing them to make informed decisions throughout the year rather than reacting to issues after they arise. A proactive relationship with an accountant transforms financial management from a reactive task into a strategic advantage, helping businesses grow sustainably and avoid cash flow crises.
- Separate Business and Personal Finances – Keep business and personal expenses separate to maintain clear financial boundaries.
- Set Aside Reserves for Tax Payments – Allocate a portion of profits for tax obligations to avoid cash flow surprises.
- Engage a Professional Bookkeeper or Accountant – Ensure accurate bookkeeping, compliance, and timely reporting with expert help.
- Cash Flow Forecasting and Budgeting – Plan ahead by forecasting income, expenses, and tax payments to manage cash flow effectively.
- Review Loan Structures and Interest Rates – Explore refinancing options to manage rising interest costs and maintain financial flexibility.
Conclusion
Lisa’s story highlights how even profitable businesses can face cash flow challenges without proper financial planning and tax management. At Investax, we understand that navigating business finances and tax obligations can be overwhelming, especially for new business owners who need extra guidance.
Even if you have the best accountant in the world, they can’t help you unless you proactively engage with them throughout the year. Waiting until the last minute to address your tax obligations often leads to costly mistakes. If your current accountant is not a business tax specialist, it may be time to explore other options.
At Investax, we offer proactive, hands-on support to help you stay ahead of your tax and cash flow challenges. Contact us today to schedule a consultation—let us provide the expert guidance you need to manage your finances confidently and grow your business sustainably.