The Most Undervalued Component that Helps Increase the Profitability in an Efficient Way
A general tendency of any entrepreneur while looking at his business income statement would be to calculate his earnings by just looking at the Net Profit amount. This is not at all wrong as he put in so much effort to make his business idea into a profitable one. However, when you are trying to maximize your profits, to say precisely, to increase the profitability, you need to ‘remove the temptation’ to borrow or withdraw profits just to support your luxury lifestyle. Although it is your own money rightfully earned but to make it create the wonders for you in the longer run, we will keep it separate and inaccessible for now. Let me discuss this further in detail.
The Two No-Temptation Accounts
This idea suggests that whenever you receive money in your bank account, you should immediately transfer this amount into two no-temptation accounts: PROFIT and TAX. The reason behind this is because whenever you see your bank statement and see the income received, you are most likely tempted to ‘borrow’ the money to meet your expenses. The moment you transfer the money to your no-temptation accounts, the money gets inaccessible for you to use it. Now, while you create separate bank accounts for Profit and Tax, you need to make sure that these accounts are highly non-reachable. You will have to make sure that to get access to these accounts you will need to put in special efforts, for example, visiting the branch to withdraw money. You will have to make sure you do not use any internet banking or easy withdrawal facility to use the money transferred to these accounts. These two accounts should be ‘Out of Sight’ accounts where you can check the balance available but difficult to withdraw money.
Why Separate Bank Accounts
When your bank statement shows the balance available in your bank account, you will be tempted to use it for your expenses – mostly unnecessary spends. Instead, when you transfer your money from primary bank account to the separate Profit and Tax accounts which are purposefully kept not so easily accessible, you will not consume it because you do not have it. When you create a separate Tax account that is kept only to pay government dues, you will not be tempted to use this money to pay off your other expenses or purchases. Similarly, while keeping aside some money in your Profit account, you make sure that it will not be borrowed to meet other day-to-day expenses.
The benefit of doing this is not only to accumulate profits but also prevent you from wasting your money towards gratuitous means. The entrepreneurs will be focused on spending only what is available in the primary bank account.
The Loss Aversion Concept
It is a psychological influence that makes us impenetrable to giving up what we already have, even if it is for a larger benefit later. For example, many people would suggest you spend more money to pay less tax. This idea is certainly vague in a way to save money from paying the tax you are spending more money towards unnecessary means. Ultimately, the money is going out of your pocket be it either to the government by way of taxes or to other parties. Hence, it is very crucial to reserve money to pay for taxes as it is the money owed by the government.
The concept is exemplified as below:
Assume that two taxpayers, Mr Payable and Mr Refund have the same tax liability of $10,000. Both the taxpayers’ employer deducts tax at source but in the case of Mr Payable, the tax deducted is only $9,000 while in case of Mr Refund the amount is $11,000. Therefore, Mr Payable will have to pay $1,000 as his tax liability and Mr Refund will receive $1,000 as a refund. Since Mr Payable did not pay the tax in advance, he will try to find ways to reduce his tax liability, and his consultant advises him to spend the on reducing the tax liability and booking an expense. The loss aversion concept works this way only where a lot of accountants will reduce the tax liability and ask clients to spend more. Here in this case the money is lost either way. However, the psychological effect of this is that people tend to spend more to save tax.
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