How do you know how much to save for Tax?
At a meeting with a relatively new client recently, we were asked how he knew how much to save for his Corporation Tax as each month went by. This is a really smart question, as saving for your Corporation Tax as you get payments in from your customers is the easiest way to avoid a panic when the due date arrives. We talked him through the figures, and showed him how to work out how much to save for tax each month.
The calculation is actually quite simple, but assumes you have some key numbers to hand:
- Gross Profit Percentage – This is the gross profit achieved divided by the turnover of the business. Ideally, you would use the most up to date figures available, but if you only have those for the last set of annual accounts, use those.
- Monthly average overheads based on the last 12 months.
Using these two numbers, you can calculate the Breakeven point for your business.
You do this by dividing the monthly average overheads by the gross profit percentage, then multiply the result by 100.
- 60% Gross Profit Percentage
- £18,000 average monthly overheads
Calculation: 18,000 divided by 60, multiplied by 100 = £30,000 Breakeven Point
Once you have your Breakeven point, you know that every £1 after that is profit.
From here you can calculate the Corporation Tax that will be due on each and every pound you make in sales.
To do this:
Multiply the number of pounds beyond your breakeven that you have reached each month in sales by the Gross Profit percentage and the Corporation Tax rate.
Using the figures from our example above, the Gross Profit percentage is 60%, and we know that the Corporation Tax rate is 19%, so we can calculate the percentage of every pound sold, and know how much of it we need to put away for tax, as follows:
£1 x 60% (Gross Profit percentage) x 19% (Corporation Tax) = 11.4% tax due on each pound of turnover beyond the Breakeven Point.
One of the biggest problems that we see with businesses, particularly if they are seasonal, if they are quite new, or experiencing rapid growth, is that cash comes under pressure. By putting away enough cash to cover the tax that will become due as it comes into your bank account, you can avoid the headache of finding a lump sum at short notice. You will know how much to save for tax as you go through the year.
This calculation should be repeated on a regular basis, ideally monthly, to check how much of your turnover is beyond Breakeven, so that you know exactly how much to save for tax.
If you’d like some help to calculate your breakeven point, or to check your calculations, please do get in touch!
PLEASE make sure that you substitute your own figures for those shown in the examples above; the only figure used above that isn’t an example figure is that of the Corporation Tax rate.