Tax returns are a stressful time for anyone who runs their own business or is otherwise self employed. Essentially this tax is a debt that you have to pay off at the end of the year and it’s normally a very significant one. You can put money aside in the hope that you will be able to pay this tax debt off very easily, but in many cases you will find yourself getting a nasty shock when the amount comes through and often this tax debt can become a real debt as we are forced to borrow money to pay it off – and this then can become a slippery slope that sees our finances really start to struggle.
As a result it’s crucially important to think about your tax debt before you have to fill out and pay your return. One good way to do this is with something called ‘financial modelling’. For those who are not familiar with that term, financial modelling is essentially the act of creating ‘models’ of your finances in spreadsheets, financial modelling software or programming languages. From here you can then change the data to see how you can change your real life finances and what affect small tweaks would have, or you can visualise it by putting the data into a graph or chart.
This then allows you to calculate your tax debt long before you need to pay it, and to see what you could do to change it. For instance then, using a spreadsheet you could input all of your income, all of your interest, all of your assets etc, then subtract all of your expenses, charitable spending or anything else you are going to claim back, and then work out the tax you’ll owe for what you have left. This then will enable you to see exactly how much tax debt you owe.
Furthermore this will allow you to then realise if the amount of tax you are going to owe is more than you can pay and so whether you need to start putting more money aside. At the same time though it also means you can try claiming back more of your expenses – such as perhaps your phone bill or more of your rent if you work from home and you can use your financial modelling to see what you would have to claim back in order to make your tax debt something you can afford. Then should you get audited or inspected you will have all of your workings in the system to show and you won’t even have had to have used an expensive accountant.
This is only one use for financial modelling, and as well as tax debt you can use it to calculate all your other debt and to visualise and manipulate your financial data in a digital arena where it will have no negative repercussions. It is something well worth learning and well worth practising.