I am writing to you now, because I now believe after long last there is now some certainty in what will happen in the owner managed business space over the next year and beyond. Unfortunately, the position is not what I had hoped for but at least now we know.
There are now two key issues facing small medium business. These are rising costs, inflation, and the corporation tax rate increasing. I have included my thoughts on how to tackle these two issues.
Rising Costs & Inflation
Energy is the main cost you think about when discussing current rising costs, but the other main cost that will affect the service industry is wage inflation. Wage inflation will be prevalent over the coming 12 months as businesses look to retain staff that are affected by the current cost of living crisis. From my perspective we are looking at salary increases in the accountant sector of up to 10%. With inflation being at above 8% the reality is all costs are going to rise over the coming months.
While new process and efficiencies can be made to reduce staff time i.e restaurants are increasing the use of table ordering software and cutting back on waiting staff. Here at C&C we are introducing new starter forms that import directly into our payroll system. Ultimately though all businesses are going to have to raise their sales prices while inflation remains high.
It would be my recommendation that costs are monitored, and annual sale price rises considered where possible for all businesses.
If you consider the below example, this example shows what happens to a business profit as expenses rise but sales price remains stagnant. Here I have inflation running at 8%, I have assumed that inflation affects the cost of sales and salaries only.
| Year 0 | Year 1 | Year 2 | Year 3 | ||||
| Inflation | 8% | 8% | 8% | 8% | |||
| Sales | £300,000 | £300,000 | £300,000 | £300,000 | |||
| Cost of Sales | £60,000 | £64,800 | £69,984 | £75,583 | |||
| Salaries | £90,000 | £97,200 | £104,976 | £113,374 | |||
| Other Admin Costs | £40,000 | £40,000 | £40,000 | £40,000 | |||
| Profit | £110,000 | £98,000 | £85,040 | £71,043 | |||
| Net Profit % | 36.67% | 32.67% | 28.35% | 23.68% |
You can see in the above example how the profit drops over 3 years from £110,000 to £71,043. This is a 35% drop in profit.
What is not shown above is what’s called the time value of money.
Assume that in year 0 a loaf of bread costs £1. In year 3 theoretically with 8% inflation a loaf of bread would cost £1.26
| Year 0 | Year 1 | Year 2 | Year 3 | ||||
| Bread | £1.00 | £1.08 | £1.17 | £1.26 |
In year 0, your business earned you enough money so that you could buy £110,000 loaves of bread.
However, with your lower profit and higher bread costs you can now only buy 56 Loaves of bread.
The effective of inflation is hidden in numbers, but in just over a 36-month period your earning potential could drop by nearly 50% if you don’t act.
Solution:
The only real way to combat rising costs and inflation is unfortunately to charge on some of these costs to your customers.
The next question would be how much do I raise my sales price by. This is a complex question and will be unique to each business owner. The answer will be based on a few factors:
- Inflation rates per year
- Cost rises per year
- Customers tolerance for increases
- Business owners need to improve or stabilise profits.
But the only way to know some of these answers is to have access to monthly accurate accounts. Information is key to planning.
For most our clients we have monthly profit and loss accounts, and we can compare year on year costs, sales, and profits. It is therefore possible for these clients to be given advice on what they would need to raise sales prices by in terms of a percentage to maintain their profit figures.
If you require any help with this planning, we will be happy to help. The help provided will be bespoke for each client and will need to be subject to an additional one-off fee.
We can also provide your year-on-year reports or show you how to access these reports on your Xero/QuickBooks so that you can undertake analysis yourself which is the beauty of cloud-based accounting at no extra cost.
Mr Hunts Tax Changes
Jeremy Hunt on the 17th October 2022 as reversed nearly all the tax savings announced just a few short weeks ago. There are two taxes I wish to bring to your attention as business owners
Corporation Tax
It was long promised by Liz Truss that she was going to reverse the proposed corporation tax rise from 19% to 25%. Therefore, I never felt the need to advise the client base on any changes as we were certain it was all going to be repealed.
There is a small business limit that will be applied, if your profits are below 50K your rate will remain at 19%.
For any Ltd companies over 50K profits, will now be facing a corporation tax rate of 25% rather than 19% on your profits.
There are two major tax planning points that I will be using in order to reduce this additional tax burden that you should consider.
- Employer Pension Contributions
- Electric Car Purchase
Pension Contributions
Contributions into a pension fund reduce taxable profits inside a Ltd and move the cash into your personal pension fund without being subject to income tax. Thefore for each £10,000 that you put into a pension fund as an employer’s contribution you will be saving £2,500 in corporation tax.
The downside to this planning is you cannot access the cash until 55. Even at 55 I would recommend that you do not access the cash until you finish trading and wish to retire. Taking cash from a pension reduces the amount that you can contribute to the pension from 40K per year to 4K per year.
You can use pension funds to purchase commercial buildings. Purchasing your office is one way to control rising costs.
If you require any bespoke advice on pension contributions, we would be happy to advise you and recommend an FCA registered pension adviser included in your fee you already pay C&C.
Electric Cars
It is possible for your Ltd company to purchase an Electric car and received a full corporation tax write down in year 1.
I have written an extensive blog on this, if you are interested in an electric car please go here.
National Insurance
This is the only good news, the increased national insurance rates that took effect in July 22 are to be reversed in November as planned.
This will benefit all employers, sole traders, partnerships, LLP and any employees.
Conclusion
I have only included in my advice above changes I deem important when running a business should you have any questions or comments please feel free to run them past me.
The key to success has not really changed, it has just become more important. I believe planning, comparing the plan against the actual and then adjusting your plan going forward based on the results is the key to success.
Bring able to make those major decisions early and decisively and then seeing if those decisions work towards your goals.
If you feel I can help in any way, please let us know and I will be happy to take a meeting with you to discuss options.
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