I’m often asked about modifying the Profit First system specifically for different types of business structures. It is true that each business structure type, and how the structure is used, will present unique challenges. However, the fundamentals of the Profit First system remain the same.
Here are some common questions I am asked in regard to running Profit First in Australian Sole Trader businesses.
A sole trader is ‘the business’. Do I need an Owner’s Pay account?
For me, the answer is absolutely ‘yes’. While I understand that all of the business’ profits are automatically taxed in your hands anyway, using a Profit First Owner’s Pay account can still be incredibly useful.
The Owner’s Pay account accumulates funds based on your Profit First Percentages. The business owner (you) draws a fixed salary from that account each week, fortnight or month. Assuming the salary level has been set at a level the business can sustain this will mean that in good months the account will accumulate a cash buffer. In your slower months this buffer will pay your salary. This can really help business owners who are constantly stressed about the variable nature of business income. Essentially, we have created a regular, steady personal income for you from a business that may not have regular income itself. For many business owners this is a source of great comfort.
In regard to superannuation, using the owners pay account also allows for owner’s payments to be clearly tracked. Should the sole trader wish to make super contributions they can put aside a percentage of each wage payment.
Please note: as a sole trader you are not legally obligated to make super contributions for yourself. I always recommend you seek professional advice around this. Depending on your age and total income superannuation is not allows the most tax effective way to invest your money.
As a sole trader can my Profit and Owner’s Pay accounts merge into one account?
The Profit and Owner’s Pay accounts play very different roles in the Profit First system. As such my recommendation is always to have two accounts.
- The owners pay account is responsible for providing you with your regular personal income. Your wage for services provided to the business;
- The Profit Account accumulates funds which are allocated quarterly to either debt reduction, emergency savings or business owner rewards.
For the system to work properly those funds should be kept separate!
My car is also the business car – which account should pay the expenses?
While this question comes up with all business structures it is far more common with sole traders. It’s an important question to answer because it highlights a point at which business owners can manipulate the numbers to allow Parkinson’s law to continue eating up the business’ cash. If something really should be a business expense but we allocate it to personal just to get our total numbers closer to our Target Allocation Percentages then we are cheating ourselves.
My rule of thumb when it comes to expenses that are shared between the business and yourself personally is to use the ‘predominant use test’. If the expense is predominantly (more than 50%) personal, then you pay for it from the owners pay account. If the expense is predominantly business, then your Operating Expenses account should pay for it.
The Predominant Use Test and Tax
It’s important to note that all we are discussing here is where the cash comes from to pay the bill(s). It has no impact at all on whether your accountant can claim some of the amount as a tax deduction or not. Keep clear records of all expenses which you feel are partially business and partially personal. Give these records to your accountant at the end of the year. In the case of a motor vehicle these records should include your logbook.
My message for all Sole Traders is this – treat your business the way you would any other business structure when it comes to Profit First. Set the accounts up the same way everyone else does. Treat the business and yourself as two separate ‘entities’ when it comes to managing cashflow.
If you stick to that approach I guarantee you’ll avoid any of the pitfalls that come with treating your business income account as a personal ATM!
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