How do I know what to pay tax on if I dont know my profit for a few years?

[squidgearooney]

Hi all,

this may sound like a stupid question to some people but here goes anyway....

I have had a business idea and put together a business plan (all looks good so far).... now I intend to speak to an accountant obviously but I dont want to go in there looking like the total idiot I am.

The business will involve me receiving money from people for a service that I will be providing. The majority of my income will come within the first 2 to 3 years, however, my forecast in my business plan will mean that I will still be paying some of this money out upto the end of year 5.
What I dont want to do is declare a profit on which I will undoubtedly pay large amounts of tax and then end up with not enough money to cover the outgoings for years 4 and 5 simply due to paying it out in tax.

Can anyone advise on what I would do here and if there is any way I can avoid this happening?

All comments greatfully received :)

Paul

[hendyphilhendy]

I would have thougt that as part of the business plan you would be expected to project the profits/ losses. If so use current tax rates as a basis for calculation. Timing is key from a cashflow point of view but the rules are generally quite clear. I think it is important to include the taxation element as this will have an effect in the later years.

[KidsBeeHappy]

Income you receive for services you haven't yet provided is called deferred income. You take it out of the turnover (and therefore also profits) for the year that it was actually received in, and you add it back to the turnover/profits over the years that you provide the service.

So, if you get £500 for 5 years of service, and you get paid £500 in advance, what yoru turnover will show for each year is Y1 £100, Y2 £100, Y3 £100, Y4 £100, Y5 £100.

So, your turnover will match the expenses that you incurr to provide the service, and you pay tax on the profits you have earned, rather than income you have recieved.

(and the balance sits on the balance sheet each year as a liability - ie money you've received that you haven't yet earnt).

[squidgearooney]

I would have thougt that as part of the business plan you would be expected to project the profits/ losses. If so use current tax rates as a basis for calculation. Timing is key from a cashflow point of view but the rules are generally quite clear. I think it is important to include the taxation element as this will have an effect in the later years.

thanks phil, you are right with regards to this needing to be taken into account with the business plan, it was a friend of mine that pointed this out and hence I looked into it a little and ended up here :)

The part I dont understand is that lets say at the end of year 3 I have all my incomings, do I have to declare this all as profit when quite clearly it will not be profit as approximately 65% of what I will have at that point will be paid back to my customers over years 4 and 5.

if it was a one year turnaround business i would obviously take my income, less expenses, overheads etc and declare my profit to pay tax on.

this is how i think the business should run but just over a 5 year period.

a little confusing i know but i just havent got a clue and the hmrc site is full of terminology which i basically dont understand. just dont want to pay silly money to an accountant just to sit there and be a thesaurus for me lol

paul

[squidgearooney]

Income you receive for services you haven't yet provided is called deferred income. You take it out of the turnover (and therefore also profits) for the year that it was actually received in, and you add it back to the turnover/profits over the years that you provide the service.

So, if you get £500 for 5 years of service, and you get paid £500 in advance, what yoru turnover will show for each year is Y1 £100, Y2 £100, Y3 £100, Y4 £100, Y5 £100.

So, your turnover will match the expenses that you incurr to provide the service, and you pay tax on the profits you have earned, rather than income you have recieved.

(and the balance sits on the balance sheet each year as a liability - ie money you've received that you haven't yet earnt).

Thank you very much Boxby, thats absolutely spot on and helps me alot. this means i can run my business as i planned. Thanks again, i owe you one :D

Paul

[MyAccountantOnline]

Hi all,

this may sound like a stupid question to some people but here goes anyway....

I have had a business idea and put together a business plan (all looks good so far).... now I intend to speak to an accountant obviously but I dont want to go in there looking like the total idiot I am.
Paul


Paul if you go and see an accountant and they make you feel like an idiot - go and see another one.

Us accountants work long and hard to learn what we do, and any decent ones will never expect a client (especially someone new to business) to understand our weird and wonderful tax system, after all thats what we are paid for!

So please dont worry - a decent accountant will explain how you will be taxed, when it will be due and most importantly how to ensure you pay the least amount possible:)

[Jenni384]

Well said Nicola!! :)

Paul - best of luck with your business and good luck finding the right accountant for you.

[MyAccountantOnline]

Well said Nicola!! :)

Paul - best of luck with your business and good luck finding the right accountant for you.


Thank you very much:)

[Tom McClelland]

<snip Boxby's fine explanation of deferred income>

Exactly so. For example we do this when we sell 2 and 3 year licences for our product.

[hendyphilhendy]

Agree totally with Boxby and Nicola - both great posts, in particular the deferred income position.

With regards to talking to an accountant, most (including myself!) offer a no obligation initial meeting in which this type of issue will be explained. And most modern thinking accountants, such as the above, will explain it to you in plain English.

[squidgearooney]

thanks to all who have given me good advice, guess I forgot that I will be paying the accountant (and probably a fair bit) so he or she should be making the effort to explain to me.

Thanks all :)

[CassioAcc]

Look for an accountant that will offer a fixed fee, that way you will get support during the year and you don't have to worry about clocking up additional fees everytime you ask a question.

Good luck