17th May, 2021
Getting your accounts in order is a key thing to do ahead of tax time, but it doesn’t have to be a chore. Chasing payments on invoices and paying creditors can be easy and helps minimise tax.
Many of us dread the impending arrival of EOFY because it means sorting out the books for the accountant.
But if you prepare early and implement healthy business habits, you’ll save yourself time, stress and, ultimately, money.
If you’re a small to medium business, getting your accounts in order is likely going to be a focus for you in the lead up to tax time, and a critical part of this means managing debtors and creditors — that’s the money you’re owed and the money you owe others.
Good creditor and debtor management gives you a better picture of your business health, as well as the direction it’s headed. And that’s important because it may have implications for your overall tax position.
As a result, it often pays to start the new financial year with no or fewer outstanding bills and invoices, so as to make managing your organisation’s books simpler.
This article covers the following key tips for EOFY:
Paying attention to debtors and creditors is crucial whether you use an accrual accounting method or a cash basis, as you’ll see below.
The accounting method you use determines when transactions get reported as income or expenses for the month, quarter, or year.
With cash accounting, you track the actual money moving in and out of your business.
You don’t record income or expenses until you’ve been paid by someone or pay an invoice.
For accrual accounting, you record income and expenses when invoices get issued, rather than when money changes hands.
For instance, if you send a customer an invoice for completed work, you record the income on the date of invoicing, even though you haven’t yet received payment.
Businesses that work on an accruals basis have to compile a list of debtors and credits at the end of the financial year to determine annual income and expenses for tax purposes.
If you pay outstanding bills before the start of the new financial year, you may be able to reduce income tax and improve company cashflow.
Debra Anderson of Anderson Tax and Consulting explains how business owners who choose the cash basis accounting method can bring tax deductions forward by a year if they pay bills sooner.
“By paying a bill on or before 30 June, the business can take up the tax deduction in this financial year. But, if the bill is paid on 1 July, the tax deduction isn’t claimable until the following financial year,” she said.
“Depending on the payment value, this can impact profit considerably and, therefore, the tax amount payable.”
Another benefit is the potential for improved cashflow if you’re a business owner that reports BAS on a cash basis.
In this situation, you get GST paid back earlier than if you pay the bill in the new quarter.
“Paying a bill on 30 June means getting the GST portion back 90 days earlier than if you paid the bill on 1 July,” Anderson said.
“Depending on the payment, this can have significant cashflow implications.”
As such, sorting out business bills before EOFY can give you handy timing advantages.
If you know you’ve made more income this year than you’re likely to next year, you may want to pay bills sooner and use the amounts as deductions to offset the current higher income.
It’s also a good idea to chase up debtors you’re waiting to receive payments from before EOFY.
Anderson identifies that, for many SMEs, their biggest current asset is their debtors’ ledger.
“However, the term ‘asset’ is an oxymoron here because having debtors means you’re financing another business, which is a risk to your own,” she said.
The risk, of course, is that they won’t pay.
“Any money tied up in debtors is useless money because you can’t use it to pay your own bills or wages or invest.
“This is why it’s important to regularly run and review your aged receivables reports and keep debtors under control.”
You can use MYOB accounting software to quickly and easily run this report.
Once you have the numbers, you’ll see how many outstanding invoices you have and the amounts of each, plus the total figure you’re waiting to be paid.
With that information, you can follow up with clients for payment.
If you think there’s zero or little chance of recovering assessable income from a debt, keep in mind that you may be able to claim that amount as a tax deduction. This is referred to as writing off bad debt.
If you account for assessable income on an accruals basis, you may be able to claim a bad debt deduction.
It’s helpful to keep a close eye on your debtor days so you can better manage the cash flow gap that occurs between receiving money into your business and paying money out.
The term ‘debtor days’ refers to the average number of days it takes for you to receive payment from customers for goods or services.
Here’s how to calculate your average debtor days: take your year-end receivables amount, divide it by annual sales, and then times this figure by 365 days.
“Knowing how fast, or how slow, your customers pay is important for two reasons,” said Anderson.
“Firstly, it’s indicative of how well you’re managing your working capital, and secondly, it’s one of the key things potential lenders are very interested in.”
Your goal, then, is to have the lowest debtor days possible.
To determine how effective you are in this area, check out industry standards to see how your numbers compare with others’.
“For example, the building industry is notorious for 30-days-from-end-of-month terms,” said Anderson. “In contrast, professional service-based businesses normally have seven-days-from-invoice-date terms, and many insist on 50 percent upfront and the remainder 50 percent payable seven days after completion.
“If you’re in the building industry, there’s no value in comparing your figure against a professional services business since the industry norm is so different.
“But if a building company’s debtor days are 30 and the industry norm is 60, that business is doing a great job managing their debtors and working capital.”
To reduce the amount of time it takes for your clients to pay you, you’ll want to invoice them immediately, with clear terms and, ideally, offering them a number of payment options.
If you have work that needs billing this financial year (depending on whether you follow cash or accrual basis accounting), start invoicing now, so you’re more likely to receive payments before EOFY.
And if you’re always on-the-go, the MYOB Invoice app offers a mobile solution to send invoices from wherever you are.
MYOB’s software also enables you to confirm that people receive the invoices you send them. That’s because documents sent via MYOB get tracked, so you know when recipients open invoices and click on links.
Make it easier for people to pay you, too, by using an invoicing template that clearly shows amounts, the due date, and how people can pay. If they have to search for information, they may delay.
Tech tools like MYOB’s platform can also send out automated reminders. Plus, software can digitise payment processes, meaning customers can enjoy self-service and pay bills quickly.
Enable your clients to choose from multiple payment options, too. They’re less likely to set aside a bill if they see a payment choice they prefer, such as credit card or BPAY, and you can even enable payments at the click of a button for them with Invoice Payments.
Some other tips to encourage earlier payments include offering incentives for those who pay before the due date and changing payment terms.
For instance, instead of providing people with 30 days to pay, you could make it 14 or even seven, depending on what’s appropriate for your industry and the wares you sell. This is something that should be discussed with your clientele if you do decide to make a change, or as you secure work with them in the first instance.
Being prepared for tax time will help your stress levels and aid your business, and the best way you can do that is to get on top of your accounts.
This article was written with guidance from Debra Anderson, tax specialist and owner of Anderson Tax & Consulting. The information it contains is general in nature and not to be considered as tax advice. For advice on your individual situation, MYOB recommends working with a specialist tax advisor.