To truly conquer your cashflow, proper planning is everything. A large, surprise expense can trigger cashflow distress and seriously undermine the long-term stability of your business. In this article we’re going to look at Capital Expense Accounts and Large Expenses Accounts. You may use one or both as part of your long-term planning process to ensure you avoid any nasty surprises.

Capital Expense Account(s)

When we talk about Capital Expenses in the realm of business we’re talking about buying Assets. Plant and Machinery, Office Furniture and Equipment, Motor Vehicles and the like. Large items that the business will use over a number of years to generate income.

Usually, items of this nature require loans of one sort or another at the time of purchase. You will recall from the Debt Freeze article that taking on debt for essential business equipment is one of the few times when debt is acceptable in Profit First. Provided you can service the repayments from your Operating Expense Account that is!

Any alternative approach which can remove (or at least reduce) the need to take on debt is to establish a Capital Expenses account. Each time you do your Profit First Transfers you set aside a pre-dermined amount which gradually accumulates over time. The long-term aim of the system is to have a large amount of cash saved up ready to buy the required asset outright rather than borrowing to fund the purchase.

Large Expense Account(s)

These accounts work exactly the same as Capital Expense Accounts but are intended to help the business pay large expenses that fall at particular points during the year. Not all your expenses can be paid monthly so planning for large, annual payments is crucial. A common example here is insurance policies. Rarely do business insurance policies offer a pay by the month option. They send the business an annual invoice which you either pay in full or use some form of premium funding product to borrow the money. In Profit First we prefer to set aside some money each week/quarter/month so that when the bill comes in we can pay it in full without having to pay interest!

Do these accounts need to be actual bank accounts?

In practice I’ve seen two different approaches here:

  1. Open an account for each item: This is pretty self-explanatory. For each large/capital item you will need funds for in the future you open a separate Savings Account with Bank 2. While this is the easiest option from a visual perspective you may end up with a lot of accounts if you get too carried away; or
  2. Open one Capital/Large Expenses account: Open up a single account and use a spreadsheet to track how much money needs to be transferred to the account and what each dollar transferred is intended to pay for. If you’re a spreadsheet person you’ll probably find this method keeps your banking structure clean. If you’re not a spreadsheet person stick to option 1!

Client Profile – How Fiona Fell uses these accounts in her business

Fiona Fell is an online marketing specialist, offering both one-on-one support as well as training for business owners who prefer a DIY approach. In Fiona’s own words “I help local business owners share their drive, hunger and excitement for their business, their products and their services through online marketing”.

Fiona is also one of Panic Atax’s Profit First Australia clients and is using the account types discussed here in her business. I thought this would be a perfect opportunity to give you a live example of some more advanced banking concepts in action.

Once the core implementation was working for Fiona the conversation moved to planning. What would she like to be able to afford to do in the business that wasn’t currently covered by Profit First? The result of that conversation was the following:

  • Fiona wanted to upgrade all of her business I.T equipment in two years’ time, at an estimated total cost of $6,000; and
  • On-going professional development is important for her business and she’d like to set aside at least $3,000 a year to pay for courses.

To facilitate these requirements we opened two new bank accounts. One for I.T Equipment (a Capital Expense Account) and one to accumulate funds to pay for study materials (Large Expense Account).

Each fortnight the required amount is transferred from the Operating Expenses account into these new accounts (as part of the PF transfer process) to ensure that the funds are available when the purchases need to be made.

Tax Implications

It is important to remember that Profit First is a Cash Flow system. We have set aside funds in these accounts to spend in the future. However, because the amounts have not been spent we can’t claim a tax deduction for them. You should work with your accountant or Profit First Professional to determine whether or not the cash sitting in this account is subject to Income Tax or GST.

My Own Experience

Like Fiona, I also use these account types in Panic Atax. I’m running the following accounts with ING:

  1. Motor Vehicle Account: My Accounting services are mobile. For client’s in Brisbane I travel to their homes or businesses rather than asking them to come to me. This does mean that having reliable transport is a must. I’ve set myself a spending estimate and a goal to buy a new car when my daughter, who is now two, turns Five. Why? Because right now my adorable little toddler is destroying the back seat of our current car and watching that happen to a new car would make daddy cry!
  2. I.T Upgrades Account: My firm is cloud based so keeping up-to-date from a tech perspective is important. As such, I like to upgrade my primary computer equipment at least every 3 years. I’m setting aside an amount each fortnight to ensure I can make this purchase in cash when the time comes.
  3. Professional Development: I also like to set aside funds to pay for education and professional development. As a Chartered Accountant I must undertake 100 hours of training and research every 3 years to maintain my registration. Putting aside some money each fortnight means I have the funds available to pay for full-day courses as they come up through-out the year.

A Quick Warning

I will include this brief warning/comment in each article regarding the use of accounts beyond the core five. It is very easy to over complicate the Profit First system by adding too many accounts. In fact, it is one of the most common reasons entrepreneurs fail to stick with the system. Please keep this in mind when considering whether the account(s) discussed in this article are right for your business.

Further Information

Read our comprehensive review of Profit First here

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