Your business should have a purpose higher than that than making money. You exist to deliver value to your customers – without that, they won’t stay customers for long. The challenge is to produce this value to your customers at a cost less than they pay for it.
Value vs Price vs Cost
Your value proposition is the benefit that customers get from using your products and services. Your product features do not drive value. Benefits that your customers realize as product or service features are applied to their circumstances drives value.
The relationship between value and price is critical from your customer’s perspective. You set the price. Your customer has a perception of your product’s value. If they value your product much more than the price then they are much more likely to buy.
The second critical relationship is between the price of your product or service and the cost to you of producing it. Simply put, your cost has to be lower than your selling price for you to stay in business for the long run.
Costs can be divided into two main groups – fixed costs and variable costs. Fixed costs are things like rent and salaries. They don’t change (within limits) regardless of how much you sell. Variable costs are directly related to how much product you sell. Examples include the buying price of goods, freight, pay by the hour outside contracts, etc. In order for you to cover all your costs, your price needs to be sufficient to cover:
- all variable costs: revenue after variable costs is your gross profit
- fixed costs: your gross profit is applied to your fixed costs and the amount left over is net profit.
If your business is a charity, profit or surplus remains important. Charities cannot operate at a loss over the long term. Continued losses will send your charity broke, just as much as it would do so for a for profit business. The “not for profit” is about purpose. Profits/surpluses are reinvested into the charity rather than being distributed as returns to members.
If your business makes money, you are very likely to have to pay income tax. In simple terms, income tax is a tax on your net business profit. Your taxable income is:
- your assessable income: most of your revenue that you receive will be assessable income. Tax law may provide exemptions for certain kinds of income, or for certain situations. You can expect that ordinary day-to-day business revenue is assessable
- less allowable deductions: It would be convenient if all your costs and expenses were allowable deductions. Tax law is complicated and something is an allowable deduction only if tax law says it is. In most jurisdictions there are general deductions and specific deductions. General deductions are most ordinary expenses. Some expenses might be excluded; however. Specific deductions are things that ordinarily are not deductible, but tax law makes them. Depreciation is a specific deduction.
- equals taxable income: Assessable income less allowable deductions is the classic tax equation. You pay tax on taxable income.
It is important to set up your accounts to prepare for income tax reporting. Our page on classification is a good place to get started. If you are based in the United States, there are multiple layers of income tax, which you can read more here.
There are detailed articles on this site about:
- an overview of business tax in the United States.
- meals, travel and entertainment deduction rules in the United States.
In some jurisdictions, you can be subject to revenue or “flat taxes”. Sometimes these are “alternative taxes”, where if your alternative tax would be higher than income tax, you pay alternative tax instead. It is like a minimum tax. If you are subject to these taxes, you will need to be extra careful. It is possible to get a big tax bill, even when you lose money in your business. This can happen if you have lots of revenue, but your costs are not under control. Revenue taxes in this case make a bad situation worse.
GST/VAT and sales taxes
These kinds of taxes are not based on your income. They are instead “indirect taxes”. They are a tax on products (and potentially services) that you sell.
- GST/VAT or Goods and Services or Value Added Taxes are charged on most, if not all that you sell. They apply regardless of who you sell to. You will generally receive credit; however, for things that you buy. This tax is really a tax on the value that you add – as measured by the difference between your buying costs and selling price. This is why in many countries it is called “Value Added Tax”
- Sales taxes are an older form of indirect tax. They apply to retail sales on physical products. If you are a manufacturer or wholesaler, you may not need to charge sales tax. They generally do not apply to services. You won’t receive credit for any sales tax you pay on business inputs, but you may be able to avoid paying using exemption certificates.
Your business should have a purpose of producing value for your customers. If you can deliver at a price lower than what your customer values it, you should sell well. In addition, if your costs are lower than your price, you are on the way to a sustainable, profitable business.
Governments impose taxes on your business. You’ll likely encounter income tax which is, in simple terms, a tax on your net income or business profit. Many businesses are also subject to taxes on the products that they sell.