Don't Let Taxes Drive Your Business

Image courtesy of Michelle Meiklejohn at FreeDigitalPhotos.net

With the recent focus on taxes in Canada, it got me thinking about how so many businesses manage their business based on their taxes and how misguided this practice can be. It doesn’t always save the business money and can lead to them making poor business decisions.

I am reminded of a person who has had a profound impact on my career and approach to business, Dr. Jim Robinson, professor and founding Dean of the Faculty of Management (known today as Haskayne School of Business). He took great pleasure in challenging existing norms of business as they were at that time. One relating to taxes and business’ attitudes towards them is pressing on my mind due to the current environment. His belief, to which I subscribe, was that a business that focuses on taxes is probably not focusing on its core business issues (or what would now be termed Key Business Indicators, KPIs), after all if you are paying taxes it is an indication that you are making money. This is particularly true for small and medium sized businesses. Now that’s not to say that I recommend that you pay more taxes than you should, I don’t. I strongly believe that once you have made your money you should focus on ways to minimise your taxes.

The worst case I saw of a business making poor business decisions for tax reasons was a client who wanted to borrow money, he didn’t need, just so he could deduct the interest for tax purposes. To show just how poor a decision this would be consider this. If we assume he borrowed $120,000 at 10% payable back over 5 years, the interest that would be paid in year 1 would be $10,900. The first thing to remember is that this is not the amount of tax relief that you would get. That would only be $10,900 x your marginal tax rate. If this was 12.5% (small business tax rate in Alberta) then the tax savings would actually be $1,363. If this client had been allowed to follow though with this idea, he would have given up $9,537 of cash to save $1,363 dollars of taxes.

As shown in the above example, preservation of cash flows should be one of the key considerations in all business decisions, which leads me to another one of Jim’s tenets; “You should invest in the things that make your business money”. For a retail business that could be inventory, for a manufacturing business it could be more efficient manufacturing processes or other parts of the supply chain. When you think about it, investing in a building ties up significant amounts of capital that could be used to invest in those things that make money or if necessary reducing debt, which not only increases profitability but also cash flow. This is why you see banks and major department stores among many other businesses divesting themselves of real estate and reinvesting the resulting funds into their day-to-day operations.

So my key message to you is this stop worrying about the taxes you pay, worry about improving your cash flow!