I came across a great question asked by a group member while participating on LinkedIn. I replied to the question on LinkedIn, but also thought it would make for great info to share with other contractors who might be asking the same question.
Here is the question:
I'm sure we all have heard, "It takes a business 3 to 5 years before it profits." Does this apply for our industry? How long should it take when you start your own business before you start to see a profit?
Here is my expanded answer:
Great question. Thanks for asking it. The answer depends on how you define profit. Many factors can be considered. Let me offer a few here.
What you charge will be a significant factor
Being profitable does have a lot to do with knowing what you need to charge so you can and will earn a profit. If a business is guessing at their rates earning a profit is a guess as well. Probably more like a HUGE RISK!
Also, consider that investments you make in your business for the tools, equipment and other larger and long term use stuff are just that; investments. The cost of those items, at least for tax purposes, is not typically assumed to be cost covered in one year of doing business, but rather the cost is typically spread out over several years. The idea is that these items are "invested in" using profits so they will eventually help provide more income and profits than they originally cost.
To summarize, the more you charge the more profits you can earn and therefore the faster you can pay off your investments and show a profit.
Profit is not measured only by how much you have left in the bank at the end of the year
How can I have earned a profit if I have no moneyAlso consider, as a business owner you may personally be measuring your profitability including the costs of any investments for a one year period. As a result may not see a profit in the bank at the end of the year. However the money spent on those investments is still considered profit for business and tax purposes. This is the case because when filing your taxes the government sees these investment type purchases as assets paid for with profits. To get tax deductions for these assets you are allowed to depreciate the assets over time to reduce their value and take tax deductions for them over several years or more. Essentially, for tax purposes, the government measures your profit by combining the money you earned and still have; along with the assets you bought using any profits, as your total taxable net profit. Also, any money your business paid out to you the owner as profit distributions over the year will be considered part of your business' total taxable net income.
These are a few reasons why a lot of business owners have to report profits earned but may not have any money left in the bank to cover the taxes on those profits. When this happens a lot of contractors view their businesses as not having earned any profit. I suggest as the business owner you can view it any way you want, but the government will still be taxing you and or your business.
Make sure you give enough attention to these important tax considerations
Again, great question to ask. I hope this article helps. Being a business owner means you have to understand how to manage and protect the profits you earn, but at the same time manage how you will be taxed on that same money. By not knowing or ignoring these considerations you can be working hard to make money while profits that could have stayed with you are going out the door to the government as taxes. That said there are a lot of great reasons to have a proactive accountant helping you and your business instead of a historian type accountant who only files your taxes for you when everything is already said and done for the year.
Now, go on out there and generate some profits so you have to pay even more taxes next year! But, don't pay any more than you have to!
Shawn McCadden founded, operated, and sold a successful design/build company. A co-founder of the Residential Design/Build Institute, he speaks at industry events and consults with remodelers about owner issues, management, lead paint regulations and other industry issues. ShawnMcCadden.com email@example.com