Ever since income taxes were introduced, everyone has hated paying tax. Believe it or not, there was a time when people didn’t pay tax. They also didn’t drive cars on paved roads, didn’t have telephones, couldn’t walk in to a hospital and didn’t have to go to school. Today, we all hope that our tax dollars are well spent.
As an accountant, I once thought I was helping my client by minimizing their taxes. After all, that’s how the game was played. Minimizing taxes was supposed to help create wealth. But it didn’t. Minimizing taxes is a short-term solution that creates long-term problems. Specifically, it creates six problems.
What’s the Score?
Minimizing taxes requires low profits since tax is paid on profits. Eliminating profits through creative tax planning takes away one of the most important motivations a business owner needs: to measure whether they’re winning or losing. Business isn’t like a game of shinny hockey where the score doesn’t matter and the game ends when your feet are cold. You need to know the score. Why? So you can improve it. Several clients have been surprised to determine which products and services are most and least profitable because they never measured it…because they didn’t care…because ‘the accountant took care of it at year end.’ Whose business is this anyways?
What do you mean: “My business isn’t worth anything?”
Low profits result in low equity on the balance sheet. I have met many business owners who really like what they do and have lots of creative ideas. But, they’re frustrated with their banker who won’t give them more money to grow. The owner is mad at the wrong person. Every banker I’ve talked to has clients who are being held back because there is no equity in the business due to tax minimization and therefore the business can’t borrow to grow. The owner needs to have a heart to heart talk with their accountant and clearly outline their goals for growth. Here is the script: “I want to grow my business and make more money so I need some equity to borrow and grow. Let’s pay some tax!” Honest, this will work! When clients start to build their balance sheet, they are building the foundation for future growth and longevity.
I Hate Debt
Minimizing taxes puts too much focus on the income statement and not enough focus on the other important parts of the business. Bankers lend from the balance sheet as there needs to be equity to provide security and reduce their risk. This is why bank debt of 6% to 9% is very cheap compared to subordinated debt of 12% to 18% and equity injections which require 20% to 30%. Generating 15% to 20% profit after tax and after interest costs is a very good reason to borrow and grow your business. Leveraging other peoples’ money is good for growth.
Measure What Matters
Focusing on the financial statements fails to measure two other critical measures in your business: customer satisfaction and employee satisfaction. If your employees are happy, they’ll serve your customers well and make them happy, and that generates profits. How do you measure these things? Ask your customers if they refer business to you or ask your new customers where they came from. If you’re getting referrals, you’re winning. One of our clients is increasing their revenues and profits in leaps and bounds by focusing on the value the customer receives. And, these happy customers are referring other profitable customers. Do your employees show up and put their hands to work or do they put their heads and hearts into it as well? Ask them what could be done differently to improve their jobs and customer service. If they say ‘nothing’ then you have a problem. At another one of our client’s, listening to their employees has increased revenues 27% because everyone is committed and revved up to go.
Minimizing taxes has created a generation of whiners. Some people don’t want to pay their fair share of taxes. They’re trying to get something for nothing and want someone else to do their heavy lifting. We’re a society that’s overly concerned with being politically correct, fair and equitable or appearing successful or wealthy. Profit is not a four letter word. If you don’t want to pay any tax, you might want to rethink your strategy. After all, you wouldn’t take car buying advice from someone driving a beat up old wreck.
The Real Purpose of a Business
Finally, minimizing taxes distracts us from the real purpose of our business – to serve the customer. Minimizing tax is like playing hockey while watching the scoreboard. You need to see the other players and you need to put the puck in the net. More specifically, you need to help your customer score. You can’t do that if you’re focused on the scoreboard. You will win by helping your customer win.
What would it be like to pay one million dollars in tax? How much would be left over? The answer is: after paying a million dollars in tax, you would have more than a million dollars in your pocket. How would that feel? You’d need to buy bigger pants or a bigger purse, probably a hockey bag, to hold all that cash. That’s why growing businesses don’t minimize taxes anymore; they manage tax as part of their cash flow and overall business growth strategies.
Minimizing taxes misses the net. It’s a lot more fun creating tax problems and helping owners grow their businesses and increase their wealth.