Profit First: Using Bank Accounts Help Prepare for Sales Tax Liability By: Cyndi Thomason President, Bookskeep
By Cyndi Thomason
One of the latest worries at the top of the list for ecommerce sellers is Sales Tax. Working with a professional service like Sales Tax and More can help you tackle that worry and get the registrations and filings in place. There is another piece to the puzzle that also needs your attention. Will you have the cash on hand to make the required payments? When all of your funds are lumped into one bank account, it’s easy to forget that you may have large payments to be made to various state agencies at the end of the quarter or even larger payments that will be due after year end for those states where you file annually.
There are so many unknowns in business. However, your sales tax liability isn’t one of them. This liability is known and in some cases, those funds have been collected by you. You are entrusted with their care until the date you are required to forward them to the state agencies. An easy way to ensure you have those funds available is to create a separate bank account for Sales Tax. By doing this, you will be aware that those are not your funds; they are the various states’ funds. The temptation to use those funds to buy inventory that “will surely sell before the tax payment due date” will be eliminated, and you will have peace of mind that you are prepared when that payment is due.
This methodology of using bank accounts for designated purposes is part of a cash flow strategy called Profit First. Profit First is a cash management methodology that sets up any business for success. It works well for ecommerce sellers because it teaches them how to weather the storms and achieve their profit and growth goals.
Profit First, created by Mike Michalowicz, who is also the author of the book, Profit First, works with our existing behavior and provides a framework to manage financial activity in a manner that builds in profitability. This behavioral "law” is called Parkinson's Law. It was developed in the 1950s by C. Northcote Parkinson, a British Naval Historian. Parkinson proved that the consumption of any resource will rise to meet the quantity of the resource available. This applies to time and money, or any goods or service. In my new book, Profit First for Ecommerce Sellers, I take the Profit First methodology to the next level and customize it to address the unique needs of the ecommerce seller.
Embracing a New Equation
Because of Parkinson's Law, the traditional business equation, Sales – Expenses = Profit is destined to leave you with little left over. The Profit First equation is Sales – Profit = Expenses. The math works either way. From a behavioral perspective, if you don’t take your profit first, there will be none left over, as your expenses will rise to meet your income. In contrast, if you do take your profit first, the funds left over for operating expenses will be less. This puts pressure on you to operate efficiently and frugally, and to be more innovative. If you’re not operating in this manner, you can bet that a competitor will be.
The Profit First 4-step Process
Step 1. Creating Multiple Bank Accounts
sets you up for success by separating your cash into bank accounts created for specific purposes. Most businesses operate with a single business checking account for all business activity. For ecommerce sellers, I suggest starting with one checking account for inventory and another one for operating expenses. In addition, savings accounts are used for Profit, Owner Pay and Taxes.
Step 2. Following a Prescribed Sequence
creates a new behavior around the new bank accounts. As your Amazon or other income is deposited in your operating expense account, you will move the funds into the designated accounts based on a specific sequence. First, determine the cost of the products you just sold. Transfer that amount into your inventory account. This account will be used to pay for replenishment inventory. Your next step is to move 1 to 5%, whatever your cash flow allows, into the profit account. In this way, you will be profitable with your next Amazon settlement. Finally, the remaining amount will stay in your operating expense account. Look at your expected expenses coming due before your next Amazon settlement and make sure you can cover them with the remaining funds. If not, you should look at what you can cut or reduce. Initially, you may need to use a low percentage, say 1 or 2%, for the Profit Allocation. Take note—if you cannot cover your operating expenses, it is a signal that you may be living beyond your means.
Step 3. Removing Temptation
is based on the realization that new behaviors are hard to learn and maintain. If a growing balance in your Profit Account is going to tempt you, then move that money to an account that is less accessible, like a savings account at another bank.
Step 4. Implementing a Rhythm
optimizes the time you will spend managing your funds. To truly understand the flow of cash, you should fund the accounts as prescribed in Step 2 every two weeks. Most Amazon sellers receive payouts biweekly, so this rhythm already exists. Fund your accounts following the sequence, then pay any bills due before the next payouts. If you’re using credit cards and auto withdrawals, look at the upcoming payments and ensure that you will have the funds needed.
This is a very abbreviated description of the Profit First process. You can follow this process for a few months to understand the cash rhythm of your business. Then you can streamline the process by using percentages so that the calculations are quickly done on a spreadsheet. As you begin to better understand your cash flow, you gain control of your operating expenses and can begin to pay yourself on a regular basis. At a minimum, create that bank account for sales tax so you are prepared to make those payments without worrying about how they will impact your cash flow.
For a more in-depth detail of the Profit First method, customized specifically for ecommerce sellers, check out my new book, Profit First for Ecommerce Sellers, available on Amazon.com and Audible.