March 11, 2022
Alright, so today I’m going to walk through, at a high level, how business accounting generally works for small businesses.
I know a lot of people out there are either thinking of launching a business, or recently started a one, but don’t yet really understand how accounting works for their business.
My goal is to walk through, in very simple terms, how accounting generally works.
Now, I’m not an accountant, but I have been in business since 2014, and my office used to be located inside of a chartered accountant’s office, so I’ve learned a lot, to say the least.
Let’s get into it.
There are two types of taxes that your business will have to pay:
- Income tax
- Sales tax
Let’s dive into Income tax first.
The way that you calculate the amount of income tax your business owes, is by taking your total revenue — That is, the amount of monies your business invoices, pre-sales tax, in other words, the subtotal on the invoices that you send out — And you deduct all the expenses, again pre-sales tax, that you’ve identified as business-related.
Revenue minus expenses, and what you’re left with is your Net Profit.
Now, keep in mind that there are certain types of expense categories, such as, meals and entertainment.
In the meals and entertainment example, you’re typically only allowed to deduct 50%.
The amount of income tax you will owe will be a percentage of your calculated Net Profit number.
That percent will depend on the jurisdiction where your business is based out of, and how much profit you’re netting — Generally the more money you make, the more tax you will owe.
To learn what your percent is, you can search online for the corporate tax brackets in your state.
On to sales tax.
The way you calculate how much sales tax you owe, is by taking the total sales tax you’ve collected from your invoices — That is, the amount of local state or provincial tax you’ve charged — And you deduct the total sales taxes you’ve paid on company expenses.
Sales tax collected minus sales tax paid, and you’re left with the amount of sales tax you owe.
With that said, if your business collects less sales tax than it pays out, then instead of paying the government, you should actually get a credit or refund for that difference.
And a similar thing happens if your business does not generate a profit. Instead of paying income tax, it will often result in a credit that you can apply to lower future profits.
Now, I strongly recommend that you work with a bookkeeping software such as Xero, or Quickbooks Online.
These tools automatically calculate sales tax and net profit for you, and they even integrate with your company’s bank account so you can make sure every transaction is accounted for.
And that is business accounting in a nutshell.
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