We are in the midst of tax season, which is always a little stressful, but having Profit First implemented in your business can ease some of that tax-time stress. Profit First is a cash management methodology that sets up any business for success. It teaches ecommerce sellers how stay afloat in troubled waters and come out on the other side having met their profit and growth goals, and paid their taxes with cash on hand. Sounds great, doesn’t it? In this article we review preparing for sales tax liability.
Preparing For Sales Tax Liability
Profit First, created by Mike Michalowicz, works with the existing behaviors of ecommerce sellers and provides a foundation that manages financial activity in a way that encourages profitability. This practice is based off the idea that the consumption of any resource will rise to meet the quantity of the resource available. This applies to time and money, as well as any goods or service.
Embrace the Profit First Equation
The traditional business equation is Sales – Expenses = Profit. Because of Parkinson’s Law, that equation is destined to leave you with little left over. The Profit First equation is: Sales – Profit = Expenses. From a behavioral perspective, if you don’t take your profit first, there will be none left over as your expenses will rise to meet your income. In contrast, if you do take your profit first, the funds left over for operating expenses will be less. This puts pressure on you to operate efficiently, frugally, and innovatively. If you’re not operating in this manner, you can bet that a competitor will be.
The Four Steps to Profit First Ecommerce Accounting
Step 1. Create Multiple Bank Accounts
Having more than one bank account sets you up for success by separating your cash into bank accounts created for specific purposes. Instead of operating with a single business checking account for all activity, try having a checking account for inventory and a checking account for operating expenses.
Sales tax has been slowly creeping up on the top of the list of things to worry about for ecommerce sellers. One of the questions that worries sellers tends to be along the lines of, “Will you have enough profit to be able to keep up with the required payments?”. When all your money is sitting together in one account, it is easy to forget the large payments you owe to large state agencies.
Savings accounts should be used for Profit, Owner Pay and Taxes.
Step 2. Follow a Prescribed Sequence
This creates a new behavior around the new bank accounts. As income is deposited into your operating expenses account, you will move the funds into their designated accounts based on the sequence. Eventually this system will become a habit.
To begin, first determine the cost of the products you just sold. Then, transfer that amount into your inventory account. This account will be used to pay for replenishment inventory. Your next step is to move 1% to 5% (or whatever your cash flow allows) into the profit account. In this way, you will be profitable with your next Amazon settlement. Finally, the remaining amount will stay in your operating expense account. Look at your expected expenses that are due before your next Amazon settlement and make sure you can cover them with the remaining funds. If not, look at what you can cut or reduce. (Initially, you may need to use a low percentage, say 1% or 2%, for the Profit Allocation.)
This a great way to evaluate where you are. If you cannot cover your operating expenses, it is a signal that you may be living beyond your means.
Step 3. Remove Temptation
New behaviors are hard to learn and maintain. If a growing balance in your Profit Account is going to tempt you, then move that money to an account that is less accessible, like a savings account at another bank.
Step 4. Implement a Rhythm
A rhythm or habit will help to optimize the time you spend managing your funds. To truly understand the flow of cash, you should fund the accounts as prescribed in Step 2 every two weeks. Most Amazon sellers receive payouts biweekly, so this rhythm already exists. Fund your accounts following the sequence, then pay any bills due before the next payouts. If you’re using credit cards and auto withdrawals, look at the upcoming payments and ensure that you will have the funds needed.
Takeaways in Preparing for Sales Tax Liability
While this is a “cliff note version” of the Profit First process, following it for a few months will help you to understand the cash rhythm of your business. Then you can streamline the process by using percentages so that the calculations are quickly done on a spreadsheet. As you begin to better understand your cash flow, you will gain control of your operating expenses and can begin to pay yourself on a regular basis. At a minimum, create that bank account for sales tax so you are prepared to make those payments without worrying about how they will impact your cash flow.
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If your ecommerce business isn’t where you’d like it to be in terms of profitability, check out my book, Profit First for Ecommerce Sellers. It answers important questions about how to implement Profit First in an ecommerce business. Take control of your money and your business, and put Profit First to work for you! Contact bookskeep today to learn more about ecommerce accounting and bookkeeping.