Why even think of going into a new business
To run your own business and “do your own thing” will bring you may advantages:
- you are your own person
- you have the opportunity to benefit from your ability and creative ideas
- you will possibly earn more
- you will build a future investment with the increase in capital value of your business
- you have flexibility and able to work the hours you desire … and no one can fire you, except yourself
But the disadvantages are also there:
- you are on our own
- you need capital to set up and meet all running costs
- you have no wages if you don’t make money
- you will probably work harder and longer
- you are subject to the many risks involved in “running your own show” … and
- you can lose everything if it doesn’t work out
So before taking your first steps in setting up a business, make sure you have given the project a lot of consideration. Many people rush in with little thought. The prospect of being your own “boss” and making a “fortune” can cloud some basic but vital issues.
Lack of planning and proper assessment is the reason for the high failure rate of so many new businesses today. Keep your feet firmly planted on the ground when researching a business opportunity. Your accountant may be of assistance in the early discussion stage. But don’t, repeat don’t take your accountant’s word as “gospel”.
Accountants sometimes have a tendency to be inflexible. Many are good –especially those who have had first-hand experience setting up their own practice. Many more “haven’t got a clue” as to what they’re talking about. The reason? All theory – little practice. Talk to someone who’s been through the “school of hard knocks”.
If you are new to running a business
No one person or company can pretend to be totally expert on every area of business, but countless numbers have experienced most of the problems, frustrations and worries that go with setting up, owning and operating a number of businesses. This section is written for the express purpose of offering a few pointers, because so many people go into business without any planning or serious thought. The view of the IRD should also be clearly understood.
Things to think about if it’s all new to you
Before going out on your own, make sure you cover these points:
- Are the prospects for that product or service reasonably profitable – considering the risk and capital outlay involved?
- Have you sufficient capital to “see you through” the initial stages when you are building up the business?
- How will it affect your family, friends and their lives?
- What happens if it fails?
- How much competition is around? If not very much, as yourself why? A profitable business always draws others unless it is something new.
- Be very careful of goodwill. This may be for a business name, contacts, client lists or a long term lease of premises. Often this item is well overpriced and should be allocated over assets depreciable to the new purchaser.
- Will you operate as a sole trader, partnership, trust or company, and does tax have any bearing on this decision?
- What’s the minimum you will need to make in order to provide for business costs and usual living expenses, and should you make drawings for yourself?
- Work out some sort of budget. A rough plan of what to expect is better than no plan at all.
- What do I need to keep in the way of books and records, and what about other items such as tax registrations, insurance, telephones, stationery etc?
- Have you discussed this with your tax adviser?
These questions should be settled after discussion with your adviser. Business today is a specialised field – it requires specialised advice.
You must be prepared to put in the hours (at the early stages) to be successful.
Make sure you are actually running a business
In determining whether a business is being carried on or not, 2 questions should be taken into account:
- Are the operations such that they can be said to be a business undertaking, with the profits or losses being taken into account for tax purposes?
- Should they be disregarded for tax purposes as being only a hobby, or carried on in such a small way that receipts merely defray expenses?
- Remember, the fact that the transactions of a business may be illegal (e.g. sex workers) in no way affects the owner’s liability for tax.
Before deciding the type of entity you want to run your business under (i.e. a sole trader, partnership or company) you need to first determine whether you are in fact conducting a business activity.
Generally you are in business when you
- start charging others for the goods/services you provide
- supply goods/services on a regular basis
- intend to make a profit from doing so
To decide whether you are in business IRD will look at
- the nature of your activity
- how much time, money, and effort you put into the activity
- how long you have been doing the activity and your future plans for the activity
- how much you make from the activity
- whether you run your activity in a similar way to most businesses in the same trade
- whether your aim is to make a profit
If it is clear you are not operating a business you are said to be conducting a “hobby activity”.
If your business is just a hobby
The Tax Laws defines a business as “an undertaking carried on for profit”. An artificial situation is sometimes created by taxpayers who have an enterprise that they are fully aware can never be profitable. This “business” will show a loss year after year which is offset against other income (usually salary and wages) with the intention of reducing liability and often achieving a capital gain.
Where the Commissioner of the IRD feels that the undertaking is not carried on for pecuniary profit, he has the power to label the venture a “hobby” and not a business, thereby ruling that any income received is not assessable and accordingly no expenses can be claimed.
Basic advice for new business owners
- Advisers – Find a good accountant and a good lawyer. If necessary talk with a business coach before your start up.
- Times – Set times for attending to your business. Keep to normal business hours, if you can, so you have free time to spend with family and relaxation.
- Routine – Finalise a daily routine for yourself. Once you enter your office (whether at home or outside) grab a cup of coffee, check emails and faxes, attend to urgent paperwork and write out your “to do” list for the day.
- Hours – Agree with your business partner or spouse on the number of hours you will put into your business every day and every week. This is necessary if you are at the same time holding down an existing full time job. The hours may include weekends, as well as public holidays. Make sure you don’t work the full weekend, because balancing time for work with time for play (and family) would, in the long run, be far more productive and healthy for you and your business.
- Calls – Set a time during the day (suggest in the early afternoon) for returning telephone calls or email responses etc. Remember that the first few hours of your day are the most productive. The hours from 8.30am to 1.00pm should be kept aside for carrying out productive work that is able to be charged out. Don’t make the mistake of answering all emails as soon as you sit down at your desk. Emails can distract and it wouldn’t be too long before you’d find that 2 hours of the morning had passed and you hadn’t even opened your mail.
- Messages – If possible request for all your calls to be held for a response later, or switch to a message service or answerphone if working from home. Try and have minimum distractions so you can attend to your own work early while you are still fresh.
- Expenses – Calculate and set down all expenses involved in running your business to be paid out in cash either weekly or monthly. Make sure you have enough funds to meet power, telephone, Internet and rental expenses each week or month. If you need to take on staff, see if they can work part-time only until you have enough work for a full time position.
- Goals – Set down your goals. Be clear on what you wish to earn in your first year. Be realistic because you have to take into account that the business will require time to build up to profitability. The amount you earn should be sufficient to meet your daily living expenses and have a little to spare. You may find you have to juggle running a small business alongside working for a boss so there was sufficient money coming into pay the bills each week. If you are charging out your services on an hourly basis, make sure you do your calculations (perhaps with the help of an accountant) so that your charge out hourly rate is not low, but enough for you to make a profit.
- Records – Put proper records in place for all your financial transactions, as well as all other documentation relating to your business. It is critical that you have sound financial recording of all matters relating to your business. Your accountant will need accurate records from which to complete financial accounts, not only to enable you to monitor how the business is going, but also for taxation purposes.
- Computer – Install adequate business programmes on your computer so you can run your business efficiently. If you are not computer literate, then it would be a good idea for you to take basic computer course. Also, learn about the basic software packages that could be needed in your business.
- Staff – If possible, stay away from having employees until the business can afford them. It is best to outsource your work to independent contractors because they will charge only when work is required. As the work they do for you is usually chargeable to your clients and customers, the cost of their service is covered from the revenue generated.
- Plan – Make sure you have a good business plan. Make this as simple as possible. Your business plan will set out the goals you want to achieve in the business and a method of how those goals will be met. The financial part of the business plan is important because the figures tell you early whether you would make a profit on attain a certain level of sales.
Remember – failure mainly hits small businesses
There are many reasons for business failure, but there is only one conclusion. – Lost jobs, lost investment, lost dreams and lost hope. Business failure hits those businesses newly commenced much harder than those that have been around for some time. It is a fact that the longer you stay in business, the better your chances of survival. This would be because not only are you learning from your mistakes, but also the business starts to build up a clientele and a turnover, as it grows and as its fortunes improve.
Even though business failure occurs with businesses of any size, it is mainly the small businesses that are exposed the most, simply because they don’t have the backup of extra funding and resources possessed by larger businesses and companies. The smaller the business and the shorter the time it had been trading, the lesser the chance of potential funding from banks or other institutions being available.
Also, business failure is not always the result of problems within one’s own business, but can come about because of the domino effect of the failure of other businesses one deals with, whether as a customer or as a supplier. Take time to learn and recognise the early signs of potential failure in your business so you can put strategies in place before the situation becomes irreversible.
Decide your business structure early
A business structure is the form, or type of business entity, under which you choose to run your business. There are a number of structures you can choose and each one has advantages and disadvantages. The structure you finally select will depend on the type of business you run and also on the objectives, both financial and personal, incorporated in your business and personal goals.
The choice will also depend on the size and nature of your operation. Whether you are buying or setting up a new business, the legal considerations that may be involved will also affect the type of structure or “legal entity” you will adopt. Most small businesses in New Zealand are operated as sole traders, partnerships, companies, trusts, or other less used structures such as cooperatives, etc.
Operate business as a sole trader, partnership or company
1.0 Sole trader
A sole trader is a person trading on their own.
The sole trader:
- controls, manages and owns the business
- is personally entitled to all profits
- is personally liable for all business taxes and debts
As a sole trader you can usually begin the business without following any formal or legal processes to establish it. You may employ other people to help run the business.
In a partnership, two or more people run a business together.
- shares responsibility for running the business
- shares in any profit or loss equally, unless the partnership agreement states otherwise
- is liable for any debt within the partnership
Most partnerships are established with a formal partnership agreement.
The partnership itself does not pay income tax. Instead it distributes the partnership income to the partners. The partners then pay tax on their own share.
Income, tax credits, rebates, gains, expenditure or losses allocated to a partner in an income year will generally be allocated in proportion to each partner’s share in the partnership’s income under the partnership agreement.
2.1 Limited Partnership
A limited partnership exists as a formal and legal entity in its own right. It is separate from its partners. To register a limited partnership you need to do so with the Companies Office. Go to the Companies Office website.
A company is a formal and legal entity in its own right. It is separate from its shareholder(s) or owner(s). To register or incorporate a company under the Companies Act, you need to:
- Do so by going to the Companies Office website
- Pay the small cost involved for registration.
The company itself (not the shareholders) own the assets and liabilities of the business and is responsible for all its debts. The shareholders’ liability for losses by the company is limited to their share of ownership of the company.
3.1 Look-through companies (LTC)
An LTC is a special type of company. It is still a separate legal entity in its own right but for income tax purposes its treatment is more like that of a partnership. To become an LTC company all of the owners must complete a Look-through company election form IR862.
12 main causes of business failure
Small Businesses Failure was caused by a number of factors but the 12 main reasons which can be termed business causes are detailed below.
- Poor business knowledge, management skills and experience
- Poor cash flow due to bad debts and inefficient collections.
- Poor financial control.
- Lack of sales and revenue.
- Failure to plan.
- Lack of capital.
- Incorrect or non-existent books and systems.
- Excessive funds taken for private use.
- Lost time in complying with regulations and red tape.
- Internal problems to do with shareholders, managers and staff.
- Other reasons such as poor pricing, lack of employee productivity, inability to get good staff, inability to arrange funding needed, lack of marketplace and competition, failure to seek professional advice as required, poor location and failure to keep up with developments in technology.
How much can you pay yourself?
You can pay yourself whatever you want from your business. Some people prefer to draw a weekly amount of say $400 per week as a wage. If you have a company, this money you take weekly is simply an advance on the business profits. At the end of the financial year the profit of your company is worked out. Your salary can then be “set” by your accountant to your best tax advantage, once the accounts are finished.
(For example, if you take $400 p.w. at the and of the year you will have taken $20,800 (400 x 52 weeks). Your company profit is $30,000 and to keep tax down, a salary of $28,000 is allocated to you. You will be taxed on $28,000. You have $7,200 still to draw that you will have already paid tax on.
The above procedure was very common in the past, but with the tightening of the PAYE provisions, many advisers consider it a dangerous procedure, as the Tax Man may fine you for not deducting tax from your wage or directors fee. Some find it a better practice to pay themselves a wage from their own company, from which they deduct tax throughout the year and pay a bonus at year end. Tax should also be deducted from the bonus. These problems emphasise the need to review the tax position prior to 31 March.
Care should be taken not to pay too high a wage, which could put the company into a loss situation, and have you paying tax on the money which would have been tax free in the company due to the loss.
The NZ Tax Guide’s 42 greatest tips for success in business life
What does it take to grow a business and run it successfully?
The main ingredient is attention to the basics, operating with integrity and following the way other successful people have run their operations.
Here are our 42 greatest business tips for you to think about:
- Advisers – Make sure you talk to other successful people who have already done it. There is no sense in reinventing the wheel and learning by trial and error if you don’t need to. Discuss it also with your family, especially your spouse. It’s best to get their backing and support because you will need it.
- Costs – Watch your spending. It’s very easy for business costs to “run right into the stratosphere”. Even when you start to make money keep an eye on your costs.
- Capital – Don’t start a business unless you have enough money saved up. You need to have enough to start up your business and to run your operation for a 6 month period (at least) until the business starts generating enough income to “fend for itself” and grow. Under-capitalisation by small businesses is one of the biggest causes of failure.
- Use others – Know your strengths and weaknesses and fill in the gaps with people (such as your advisers or experienced employees) who have expertise in the areas you don’t.
- Court – Try and settle out of court if you can. Whatever your dispute going to court will cost you thousands of dollars for your lawyers as well as a huge amount of stress and heartache let alone loss of time and productivity. Avoid any type of court action if you can. Use negotiation, mediation or arbitration rather than litigation.
- Next level – Don’t depend on your friends and family. They can help you at the start, but they are not usually the people to get you on to the next level because of their lack of experience and skills.
- Drawings – Try not to draw too much money out for yourself from the business at the beginning. If you take too much pay from your new venture it could impact on your cash reserves and leave the business with cash flow problems. Take out of the business the minimum that you need.
- Realistic – Keep your feet on the ground. Don’t chase blue-sky potential. Be realistic in all you do. Don’t show off. Use your head at all times.
- Good Products – Make sure you have good products and services. You can’t have a business unless you are selling something that buyers want. There is no point going into the marketplace if your products and services are not up to scratch as far as quality or function is concerned. There are many competitors out there and it is tough to win, let alone survive.
- Cash Flow – Watch your cash flow every day. Monitor the cash that comes in and that goes out. Your cash is essential. Once that’s gone – you’re gone.
- Enjoy – Make sure you enjoy the business you are in. If you enjoy what you are doing, you will do it a lot better and a lot faster. It has to be something worth getting out of bed for.
- Motivation – Because you no longer have to account to anyone but yourself, you must be self-motivated. Get out of bed early every day just as if you had to beat the traffic to work.
- Determination – Unless you are serious and determined to succeed in your business you will find that little will be achieved. Be “dogged” determined and persevere.
- Confidence – Be confident in your own abilities. If you have confidence in your ideas and skills there is no reason why you cannot succeed, even alongside the big operators. Get ongoing help, if you can, from a successful business friend and your confidence will grow.
- Focus – Be focused. Don’t be distracted. Keep your eye on the ball.
- Over-deliver – Always under-promise and over-deliver. There’s something about doing more for customers than what you had originally promised. It gives your business and you a good name and reputation.
- Honesty – Keep your integrity. Don’t do what many others do that involve cutting corners. Keep honest and open. Nothing gives you a better night’s sleep then that.
- Customers – Focus on your customers. Looking after your customers and pleasing them should be your number one priority. Without customers you’ve got no business.
- Skills – Make sure you possess the necessary skills to be able to carry out the type of business that you are contemplating or currently in.
- Experience – Even though it is not critical, possessing a little experience in accounting or business or finance will be a great help.
- Work – Work Hard. You will need to put in a few more hours at the beginning and for the first year or two. Tell your family and friends about this so they will understand and help you wherever possible.
- Pay your bills – Always pay your bills on time. Get a good name for it. Be faithful in this area and your suppliers will be able to trust you when you need more credit at certain times.
- Discount – If you pay early ask for a discount. In fact always ask for a discount when you buy anything. Most will give you a discount for cash. Discounts add up. No one pays the full retail price nowadays anyway.
- Tax – There are many things you can do to minimise your tax. See a good tax specialist if your accountant doesn’t specialise in this area. Never delay your tax payments because penalties from the IRD can be pretty heavy.
- Records – Make sure your records are absolutely fantastic. Keep all your communication and emails. Keep every receipt. Take a copy of all documents. Lose nothing. They will “save your bacon” one day when you have a court case and you just happen to have a copy of that important piece of paper in your files.
- Hours – Keep to proper hours. If you burn the midnight oil everyone loses out. Your family, your friends, your kids and you. You will not be rested so your performance will suffer the next day.
- Learn – Get to know a little about business and the principles of finance, sales and profit. Read as much as you can on these subjects. Attend courses. Go to seminars. Learn and learn and learn. You cannot learn enough about business.
- Staff – Take your time in picking good staff. They will be the biggest asset in your business. Promote only to character. Character is never wrong. Dismiss those who do not work as they will not produce. Reward those who deserve it. Treat staff fairly.
- Golden Rule – Keep to the golden rule “Do unto others as you would want them to do unto you” – that never fails. And keep a smile on your face. It brightens everyone’s day.
- Accountant – Get a good accountant. Someone who knows “their stuff”. They must be prepared to “fight” for you if necessary. They must be able to give you attention. They must not be afraid of the Tax Department. Get someone who specialises in small business. Make sure you can get along – that’s critical.
- Lawyer – Ditto as for Accountant plus they must be aggressive and be able to think on their feet. They must hate to lose. Get someone who can talk in plain language – not in legalese. They have to know all the tricks – legally. And they must be organised and sharp.
- Partners – Be very careful about who you bring in as partners or shareholders. The wrong people will ruin you. They will betray you and try to take your business from you. Keep control of all situations at all times. Make sure you are the Governing Director in your company and draft a Constitution in your favour before these people come in. Retain majority shareholding and keep directorship within your family or trusted associates. Make no one a director or partner unless they are totally loyal to you.
- Spouse – Don’t leave your spouse or partner out of things. Men need to know that their wives have a special ability to see the details which they often miss. Woman’s intuition? It’s there and it works. Ladies, your man is great at seeing the big picture. Best working as a team.
- Passion – Be passionate about what you do. You have talents and abilities and they’ll show through in your passion. Keep your passion. When nothing else gets you through, passion will.
- Live – Make sure you make a life and not just a living. Having a business should be long-term. It should be the investment for your retirement and an inheritance for your children and grandchildren. It has to be something that creates a life for you, not just a living.
- Stress – Watch out for worry and stress. Keep a calm attitude. Try being laid back. Learn how to relax. Take care of yourself. If the business loses you it loses its most valuable asset. Tomorrow’s another day remember.
- Goals – Don’t ever forget why you went into business in the first place. Now and then check up on yourself. What were your original goals? Are you still on track? Do your goals still excite you? If business no longer does it for you then it may be time for a change.
- Health – Keep yourself healthy and fit. Lose weight if you need to. Work in an early walk or gym session daily. Don’t diet but develop better eating habits and lifestyle. Shortcuts don’t work. Get to bed before 10 so you can get in at least 7-8 hrs sleep. Make changes that would be with you forever. “There’s no change if there’s no change”.
- Rise Early – Start the day early. Get up before dawn while the family are still asleep. Wash your face, grab a “cuppa” and enjoy the morning. Have a quiet time for yourself and reflect on things. Be thankful for the new day. Rising early helps you to take control. Your mind is clear in the morning. Before 6 am is good. There’s just something about getting up early.
- Joy – Keep happy inside. Go with the Bible proverb “A merry heart doeth good like a medicine”.
- Family – Don’t lose your family in your effort to get ahead. When you have become a millionaire it’s not your money that will bring you happiness – it will be your family. Keep close to your kids. Be their rock. They sometimes need a “secure hideout”. Be the one person they know they can count on. The person who will always stand up for them when no one else will give them “a prayer”. Love and respect your wife (or husband or partner) above all others. He or she is your greatest business asset. Value your close family. Make sure they’re there for you when you’ve reached the top by making sure you are there for them during your climb. Remember, they can’t be replaced. And no business is worth it.
- Never Quit – If you fall or have fallen get up again. Don’t stay down. Bounce back up. “Two men looked out of prison bars – one saw mud the other saw stars” It depends where you look, up or down. No matter what you’ve gone through there will always be hope. Without hope life is hopeless. Never give up – ever. If you don’t quit – you’ll make it.
Like anything else you work at for increasing your wealth, it will take courage and perseverance. Be prepared to put in the hard work required and accept that this is a serious change of direction for you, after possibly being employed and under the authority of a boss.
Being in business can be daunting for some people, but with careful planning, listening to those who are experienced and successful, and working with your advisers, the results can be very satisfying and surprising. If you keep your feet on the ground, walk humbly, listen to advice and watch and learn there is no reason why you can’t succeed enormously.
All the best.
NZ Tax Guide