Our advice is, if you have a tax debt, don’t just immediately enter into a payment arrangement
Don't immediately enter into a payment arrangement when you have tax debt. When small businesses find themselves in debt to the Tax Office, they tend to do one of two things:
1. Ignore it, with the intention of paying the debt back over the next couple of weeks or month; or
2. Call the Tax Office and enter into a payment arrangement to repay the debt over a period of time.
Problem solved; now let’s get back to work.
The issue, though, is that the problem has not actually been solved.
Sure, the symptom (i.e., stress that I owe the Tax Office money and haven’t done anything about it) might have been soothed, but the problem remains.
Address the Real Issue of Tax Debt
Entering into the payment arrangement does not address why your business could not pay its Business Activity Statement or income tax liability when it was due.
That’s the real problem, and until that is resolved, you will find yourself in the Tax Debt Trap for some time to come.
The reason for this is that if your business is in a position where it couldn’t pay, for example, its BAS this quarter, unless something fundamentally changes, it’s not going to magically be able to pay next quarter’s BAS as well as the additional amount required to repay this quarter’s unpaid BAS.
What’s the REAL Issue?
Before you can fix the issue that resulted in your business being unable to pay its tax debt, you first need to identify the issue.
There are a number of issues which, if they are the problem and can be fixed, can provide your business with a lump sum which can often clear its tax debt or reduce it to manageable levels, whilst fixing other issues are more of a slow burn.
The “Quick Fix” issues include:
Undercapitalisation
This issue is seen most often in new businesses and those experiencing high levels of growth.
New and rapidly growing businesses need capital to fund their sales, production, and collection cycles. Without these backup funds, GST and PAYG Withholding money is often used to prop up the business’ cash flow, and that money isn’t there when it is needed to pay the business’ tax debt.
To fix this issue, you need to determine your business’ ongoing cash flow needs and inject those funds either personally, through a bank, or through an investor.
Poor Cashflow Management
A business can be profitable and still lack cashflow due to several issues, such as:
1. High Trade Debtors
Unless you keep a close eye on it, the amount owed to your business by customers for work performed (Debtors) can creep up without you realising it.
There are a number of factors that affect debtor levels, but the main ones are:
- Ensure that expectations are set at the outset around the cost associated with your work and what the payment terms are;
- Invoice for work as soon as it is completed so that your customer mentally associates the invoice with the work undertaken;
- Make it easy for your customer to pay (e.g., provide your bank details, accept credit card and/or PayPal payments, etc.);
- Have both an automated and personal follow-up system so that the payment of your invoice isn’t left for any length of time (i.e., the longer it takes to pay your invoice, the less attachment the invoice has with the work performed and the harder it is to get paid);
2. High Stock Levels
Stock on the warehouse shelf is money that is not in your bank account, and if stock levels are too high, your business’ cash flow will suffer.
You need to be constantly on top of your stock levels, walking the tightrope between enough stock to ensure you can supply your customers when they purchase but not too much stock that excess money is sitting on the shelf.
If you have old stock, consider selling it for a discounted price or even at cost to realise the cash flow associated with it.
Conduct regular stocktakes to ensure that you know exactly what your stock levels are.
If your accounting system is not accurately measuring your stock levels, invest in software that will do this properly for you.
3. High Work in Progress / Poor Job Efficiency
Work in progress is the service provider’s stock and represents the costs (i.e., labour and materials) that have been paid for, for a job that is yet to be invoiced.
The longer it takes you to complete a job to invoicing stage, the more cash flow is tied up in that job, so your goal is to be as efficient as possible in completing work to realise that cash flow.
Regardless of what the issue is, whatever you do, don’t simply call the Tax Office and enter into a payment arrangement. It won’t fix the problem. Work out which of the above five issues applies to your business and fix it.
If you can’t determine where the problem is, or if you don’t know how to solve it, call us at Tax Debt Busters, and we’ll help you through the process.
The good news is that if any of these issues are causing your business’ cashflow issues, they can often be fixed relatively quickly, and a significant amount of cash flow can be cycled back into your business, which can help to pay off the tax debt in a lump sum.
We cover the “Slow Burn” issues and how to fix them in our next blog.
Getting out of tax debt isn’t easy.
