Many business owners pay for business expenses out of their own pocket, usually when cash is the only option or the most convenient option. Other times business owners are not disciplined about using their business account for business expenses and their personal account for personal expenses.
If you’re using your private account for business expenses, there is no process by which you can check that you’ve captured all of these expenses, unless you reconcile your personal bank account – like your business bank account. In a moment you’ll hopefully understand why it is a good idea to separate the two and why it’s also worth capturing those receipts paid with cash.
For every receipt worth $100 that is lost, the business owner loses $30, (or if you’re a small business owner paying 28.5% instead of 30% tax, it’s $28.50). If the purchase includes GST and you’re registered for GST, then it’s more again. Let me explain why this is by ignoring GST for the moment.
A business earns income, deducts expenses and then pays income tax on the profits. An individual earns income, pays income tax and then pays expenses with what’s left. A business basically pays for expenses with pre-tax dollars whereas an individual pays expenses with post-tax dollars.
Let’s use an example to make this clearer. You’re a business owner with $111,100 worth of income and $100,000 worth of expenses. This would leave you with the following profit and tax expenses:
$111,100 income – $100,000 expenses = $11,100 profit
$11,100 profit x 30% tax = $3,330 tax
Let’s just say that you didn’t claim $100 worth of expenses you paid out of your own pocket in the first example, but you claimed it in the second example. Now it would look like this:
$111,100 of income – $100,100 expenses = $11,000 profit
$11,000 profit x 30% tax = $3,300 tax
The savings from claiming the $100 is as follows:
$3,330 – $3,300 = $30.
I won’t go into the calculations here, but if the purchase included GST and you were registered for, and able to claim the GST, the value of that lost receipt wouldn’t be just $30, it would actually be $36.36.
There are two ways to make sure that you capture all business expenses:
- Pay all business expenses out of your business account. If you don’t have sufficient funds in your business account, transfer private funds into your business account before paying for the expense.
- Collect, or ideally capture, any receipts paid for by cash. You can do this by using a smart phone app called Receipt Bank, which allows you to take a photo and submit it with only three taps. Receipt Bank can then digitally process the expense for you so that it can be pushed into your accounting software data file.
Don’t forget that even if you are paying for all of your expenses using your company bank account, you still need to have an invoice to justify the expense (income tax deduction) in case you’re ever audited. Order confirmations, statements and the like are not invoices, so make sure that every time you pay for something that you ideally have already received a copy of the invoice.
About the Author:
Carmen Morris at On The Money Bookkeeping is a Xero certified advisor, a Xero certified payroll Specialist, a registered BAS agent, a member of the Australian Bookkeepers Network, and a Fellow of the Institute of Certified Bookkeepers: www.otmbookkeeping.com.au