Tax guide for small businesses – Part 2/3

Record keeping

Introduction

If you are involved in a business you must keep records that will enable you to prepare complete and accurate tax returns. You may choose a system of record keeping that is suited to the purpose and nature of your business. The records must clearly establish what your income and expenses are.This means that, in addition to your permanent books of account or records, you must maintain all other information that may be required to support the entries on your records and tax returns. 

Paid accounts, cancelled cheques, etc. that support entries in your records should be filed in an orderly manner and stored in a safe place. For most small businesses, the business chequebook is the prime source for entries in the business records. Be sure to open a separate bank account for your business so that you do not mix your private and business expenses.

Importance of accurate records

Accurate records are essential for efficient management. The following reasons demonstrate the need for accurate records.

a) Identity source of receipt

You may receive cash or property from many sources. Unless you have records showing the source of your receipts, you may be unable to prove that some are from sources that would make them non-taxable.

b) Prevent omission of deductible expenses

Expenses may be overlooked or forgotten when you prepare your tax return, unless you record them at the time they are incurred or paid.

c) Establish amounts paid out as salaries or wages

Under normal circumstances amounts paid to employees for services rendered are taxable. In these cases employees’ tax must be deducted from salaries or wages by the person paying such salaries or wages.

d) Explain items reported on your income tax return

If your income tax return is examined by the Receiver of Revenue, you may be asked to explain the items reported. Adequate and complete records are always supported by sales slips, invoices, receipts, bank deposit slips, cancelled cheques and other documents.

Availability and retention of records

 
You are required to keep the books and records of your business available at all times for examination by the Receiver of Revenue. A brief list of the retention periods for documents, records and books is given in the diagram below.The retention period commences from the date of the last entry in the particular document, record or book.

How to determine net profit or loss

In order to prepare your income tax return, you will need to understand the basic steps for determining your business’ profit or loss.This procedure is fairly simple and is much the same for each type of business organisation. Basically, profit or loss is determined as follows:

Income – Expenses = Profit (Loss).

You will use this formula with some slight changes in determining your profit or loss the diagram 1 & diagram 2 explain the determination of profit or loss and the distribution of income for the different types of business organisations.

Definitions of the various terms used are given below

          
Gross sales is the income a business receives. For example ABC Furniture Store sold R7 800 worth of furniture. Therefore ABC Furniture Store had gross sales of R7 800. Cost of goods sold or cost of sales is the cost of the business to buy or make the product that is sold to the consumer. It would be simple to determine the cost of sales if you sold all your merchandise during the year. However this seldom happens. Some of your sales during the year will probably be from stock that was bought in the previous year, and some of the goods that were bought in the current year will not have been sold.

To determine the cost of sales under these circumstances, you add the cost of goods bought during the current year to the value of stock on hand at the beginning of the year. From this total you subtract the value of your stock on hand at the end of the year. For example, ABC Furniture Store had R1 000 worth of furniture in the store at the beginning of the year during the current year R1 000 worth of furniture was bought from a manufacturer. At the end of the current year the store had R2 000 worth of furniture left. The cost of goods sold for the current year would therefore be:

R1 000 + R6 000 – R2 000 = R5 000.

Beginning stock + Purchases – Ending stock = Cost of sales.

Gross profit is the gross sales less the cost of goods sold. ABC Furniture Store had gross sales of R7 800. The cost to the store for the furniture sold was R5 000.The gross profit is therefore R2 8OO. Business expenses or operating expenses are the ordinary and necessary expenses incurred in the operation of the business. ABC Furniture Store incurred R1 200 worth of expenses for the salesperson’s salary commission, telephone, stationery etc.

Net profit is the amount by which the gross profit of a period exceeds the expenses of the same period. Net loss is the amount by which the expenses exceed the gross profit. ABC Furniture Store had a gross profit of R2 800; the business expenses were R1 200 leaving ABC Furniture Store with a net profit of R1 600.

In the case of a business that provides a service, i.e. physical goods are kept or sold, the procedure to determine your business profit or loss is the same as mentioned above with the exception of cost of goods sold. A business that provides only a service will not have to calculate cost of goods sold. Business or operating expenses will be deducted from gross sales (e.g. professional fees, taxi fares, services rendered, etc.) to give net profit or net loss. After you have determined your business’ net profit or loss there are differences in the way it is taxed, depending on your type of organisation.

Comparative Tax Structures

Comparative Tax Structures