Profiting from Tax Compliance

By: Eric Giltner, Senior Area Manager
Grand Forks Area Office - North Dakota District Office

SBA Office of Advocacy research has found that small businesses spend more than 5.5 billion hours fulfilling their income tax obligations. You know all too well how much time you have to spend gathering and tracking your financial information during the course of the year.

You have spent your hard earned dollars and time assembling the paperwork and filling out the forms. What are you doing with the information? Do you stick it in a file drawer and hope that you will not have to pull it out in response to an audit? Or do you use the information it contains to increase the efficiency and profitability of your business?

Now is the time to take the valuable information you were given by your accountant and place it side by side with last year’s information. Compare how well you have done or address areas that need improvement. The effectiveness of your business management is not always found on the bottom line. If this is your first year in business, you may wish to see if there is good industry information to use in your comparison. This can often be found from trade associations, lenders or perhaps even from your CPA.

Tax information always offers a very basic income statement (profit and loss statement) - Schedule C for Sole Proprietors, Form 1065 for Partnerships and Form 1120 for Corporations. From these forms you can look at basic information on sales and expense patterns. Did your sales go up last year over the previous year? Be careful with your comparisons, for during inflationary times with rising prices you may see an increase in sales without an actual increase in product/services sold.

How about expenses? What were your largest expenses? These are the areas where you want to spend additional time to review. Management of the larger costs will have a more direct impact on your bottom line. If you sell a product, you will want to look at your Cost of Goods Sold (line 4 on the Schedule C). Convert this value as a percentage of total sales as this is a far better indicator of the relative change in your business operations from year to year.

Let’s say your sales were $200,000 last year with a Cost of Goods Sold (CGS) of $60,000, you would have a gross margin ratio of 30%. If your sales in the previous year were $180,000 and your CGS was $52,200 you would have a gross margin of 29%. You lost a 1% margin, or about $2,000, which would eventually be found - or rather not found - on your bottom line. You should ask yourself the question - why? Did prices from your wholesaler go up more than what you could pass on to your customers through increased prices of your product or service? Was there waste or theft? You have to review individual cost items or changes could be lost in the summary. In this situation you could very well have made more profit than the previous year because you reduced interest costs (paid down some debt) or cut back on staff by working more hours yourself, yet you lost part of this benefit because it cost you $2,000 for product. You also should compare your gross margin to the industry average to see if you are on par with your competitors.

All expenses should be dealt with in the same way. If your accounting software program does not compute percentages for you or if your accountant does not offer financial statements that show each cost as a percentage of sales then it’s time to get out the spread sheet and put the most recent numbers side by side with percentages computed.

Sole proprietorships and small partnerships (those with receipts of less than $250,000 and assets less than $1 million) do not have to prepare a balance sheet for tax purposes, but one should be developed. A balance sheet will help you to determine how your assets are performing. It will also help you to determine the relationship of debt (borrowed money) to equity (your ownership) in the business. Using your balance sheet, compute and compare your debt to equity ratios for the last two years.

For example, If your debt was $100,000 last year and your equity was $30,000, your debt to equity ratio was $100,000/$30,000 or 3 to 1. If you find that two years ago you had $120,000 of debt and $60,000 in equity, your debt to equity ratio two years ago was 2 to 1. The increase in this ratio from 2 to 1 to 3 to 1 shows a greater dependency on debt to operate your business. This is generally not a positive sign. Ask yourself - why did equity decrease? Did you draw more from the business than you found in profits? Did you show a loss?

You’ve spent a lot of time and money in preparing financial information to satisfy federal government requirements. Why not use this information to increase your profitability and the stability of your business? You can get more information or assistance in how to use this information effectively by participating in on-line training. SBA has some great topics on their website at www.sba.gov/learning-center. SCORE also offers online training at www.score.org/content/take-workshop.

You may also consider visiting with a mentor or professional who can help you analyze the results and manage the future. SBA resource partners, SCORE, Small Business Development Centers, Women's Business Centers, and Veteran Business Outreach Centers can help you in this area. Visit www.sba.gov/tools/local-assistance for an office near you.


Eric GiltnerEric Giltner is a Senior Area Manager for the U.S. Small Business Administration (SBA). In this role, Eric trains and connects entrepreneurs and small business owners with the services they need to confidently start, grow, and expand their businesses. He frequently speaks at small business events across North Dakota and presents online webinars. Eric writes about small business topics for the SBA's North Dakota District Office newsletter, Dakota Business, and often shares business tips Thursday mornings on KNOX radio. As Senior Area Manager, Eric also works with SBA resource partners, chambers, economic developers, and lenders to support entrepreneurship in North Dakota. Prior to joining SBA in 1998, Eric served as assistant to the dean of the UND College of Business and Public Administration. He received his B.S. Degree in Geological Engineering and his Master's Degree in Business Administration from the University of North Dakota. Eric can be reached at eric.giltner@sba.gov.