Do you ever get stuck at tax time with not enough cash? FreshBooks CEO and co-founder, Mike McDerment, who was a freelancer, had to take out a loan every tax season because he was short on cash when taxes were due. It was an annual bummer. If you want to avoid this predictable cash strain, it’s best to save cash every month.
You can calculate the cash you should save by taking a percentage of your Net Profit (paid invoices subtract paid expenses). It’s best to talk to a tax accountant to determine what this percent should be as it varies based on your country and profit. Once you know your percent, you can use the FreshBooks Profit & Loss report (seen below), which calculates your net profit for you, to determine your savings.
Wait – what’s a Profit & Loss report? A Profit & Loss report (sometimes called an Income Statement) states your revenue (invoices), Cost of Goods Sold (COGS or rebilled expenses), expenses and net profit. Your net profit (take home cash) is calculated by taking your revenue and subtracting your expenses from it. The net profit on this report can then be used to calculate what you need to save for taxes.
To use your Profit and Loss report to save for your taxes:
- Update all your payments for your invoices
- Update all your expenses or import them
- Run your Profit and Loss report (instructions below)
- Calculate your savings by taking a percent of your Net Profit*
- Transfer this estimated amount from your primary checking account into a less accessible account
*Update: If you charge sales taxes, you will want to remove the sales taxes you collected from this amount using the “Sales Tax Summary” report.
*Update (Jan 25, 2011): Sales taxes are now not included in your Sales on the Profit and Loss report. To get Sales tax information, use your Invoice Details or Tax Summary reports.
And you’re done! You can even invest your savings in safe investment options such as T-Bills or put them in an high interest savings account. So this year, do yourself a favor, and save for taxes. It’s really easy, and you’ll avoid an unnecessary loan.
To run your Profit and Loss report:
- Just go to your “Reports” tab and
- Click, under finance reports, “Profit and Loss.”
- Select period “Quarterly”
- Period ending: [Current Month] [Current Year]
- Revenue: [Collected (cash based)]*
* “Collected (Cash based)” is a good method to use as it is based on the cash you brought in and can save.