Income ....and income tax

You're up and running and bringing in money and spending it. How does all of this work with profit, my money and income taxes?

Income, as mentioned in other posts, is the money you earn from running your business. There is "regular income" and there is "other income". Regular income is the result of the routine activities of your business. Whether you're a car dealer, home builder, lawyer, garbage collector or software writer, the earnings from the core activities of your business are your regular income. Many times, you will have several things directly related to what you do. These will all fall under regular income. Other income is the result of out-of-the-ordinary activities. If you are a painter and, on rare occasion, you install some electrical wiring for someone, the electrical work would be other income. If you have some of the business money invested in a CD or longer term investment for later use, the interest earnings are other income. If you're in an accident with your business-owned car and it gets totalled, the insurance proceeds are other income.

So, I billed someone for 100 widgets but haven't gotten paid yet. What do I do? Unless you choose the cash basis of accounting (I prefer to avoid this) the sale is your income but, instead of having the money in your bank account, the money goes into accounts receivable. Accounts receivable are kept separately by customer. The total of all unpaid customer balances becomes the accounts receivable figure on your balance sheet. If you sold the widgets for $2.00 each, you will have $200 on accounts receivable (as a debit) and $200 in sales (as a credit). When you get paid the $200 by your customer, you reduce your accounts receivable (credit - offsetting the original debit, for an end result of zero on accounts receivable for that customer) and increase your cash account (debit) when you take the check to the bank for deposit.

One question that may come to mind is "What is the difference between revenue, income, sales and receipts?" The first three: sales, income and revenue, are pretty interchangeable, all representing your business earnings. Sales are the revenues/income directly from regular business activity or operations. Other items, like those I mentioned earlier, are still income or revenue, but since you didn't specifically try to earn them, they don't get classified as sales. Receipts are the payments you receive. Usually, they are for the sales you've made, but if you have income from other sources, those qualify as receipts as well.

Enough on money coming in. As you use this money, you reduce your profit. That's OK. I don't know of any business that is all sales with no costs. Not even gambling or robbing banks. You have to put money in to get money out. The profit is the part the IRS and state departments of revenue like. This is what is used to figure out your income tax. So, the challenge is to figure out how to keep your tax burden low while still having enough money at home for food, clothes & the mortgage. Expect to pay taxes. Plan for them and make the payments. BUT.....use every legal and practical opportunity to avoid paying taxes unnecessarily.

For a peek into another entry, here is an extra tool you will use to help you manage your business profits, expenses and taxes. When you setup your income statement, be sure to separate expenses directly related to how you earn your money (operating expenses) from your other expenses (overhead expenses). When you subtract your operating expenses from your sales, you are left with "gross profit". The amount - best measured as a percentage of sales - should be enough to cover your overhead expenses and still have enough profit to pay for you to live. The figure left after you have paid your overhead is your net profit which is where your "take home pay" comes from. Like I've said, when you take some profit home, be sure to plan some of it for paying your taxes.

That's all for today. Have a good weekend.

Gary