If you’ve just started your business then when it comes time to look over your accounts or complete your end of year tax return, you’ll come to realise that (very likely!) your business has made a loss in year one. Now, I’ve been an Accountant for decades and it’s such a common issue that people get seriously disheartened about that I wanted to put the record straight. So allow me to quickly say it’s very common to make a loss in year one as a new startup business and it’s actually a good thing. So let’s elaborate on those two points slightly:
- 99% of startup businesses I work with make a loss in year one (usually up until year 3 in all honesty!)
- Losses mean you pay no tax and they be carried forward onto following years accounts to save even more money on tax
So that’s just a quick overview of what this article is going to be about. The fact that making a loss in your early years of business is nothing to get disheartened about, and they fact that it’s actually a good thing since it saves you money in tax! So let’s really explore these notions in more detail.
Why you’ll likely make a loss in year one
Year one is all about starting the business which usually means a lot of money is going to be spent on equipment, machinery, materials, marketing etc. So what happens is when looking through your accounts, all you see are these huge losses coming out and not much coming in to overcompensate these, but the majority of the time these losses are more ‘on-paper’ (if you will) since you’ll more than likely had the startup funds to pay for these outgoings anyway, so it’s not bankrupting you the way it looks on paper.
Most startups that I work with are individuals who have spent their life-savings on buying a load of new products, paying website designers etc, but everyone forgets that you can then list these outgoings as ‘expenses’ in your tax return. So what happens is your bank balance looks much worse that it actually is, since you paid out all this money, and although you paid for it out of your own hard-earned cash – you don’t list the startup money as income. Instead that startup money you had is just ‘nothing’, since you’ll have already paid tax on that money. So on-paper it looks very bad since there’s not really been any income, but a lot of outgoings.
Why it’s good to make a loss
So we’ve explored the main reason behind why it looks bad on paper, but now let’s dive into why it’s actually a good thing to make a loss! First and foremost, when running a business you only pay tax on income you’ve made. If you have made a big loss then you will pay no tax…it’s that simple!
Then following on from this, whatever loss you have made this year can be carried forward to next year’s tax return, meaning in the eyes of HMRC, you don’t start year two with zero and earn income from here. Instead you start in a minus to the value of whatever loss you made and that is where the bar starts for you in regards to income.
So for example let’s say you made a loss of £1000 in year one. This means that in year 2 you will start at -£1000. So the first £1000 that you earn will only then take you back zero! THEN you would actually start ‘making’ money in the eyes of HMRC. If this isn’t making too much sense then best to head over to one of my previous blogs on how tax works on income here – How Allowable Expenses Work
But the bottom line is this, making a loss is a good thing since it reduces the amount of tax you have to pay, right down to zero if it’s enough tax!
So if you do ever find yourself in the position of worrying because you made a loss in year one of your startup business – don’t panic! Most of the time it’s completely normal and is due to startup expenses. Of course if you’re finding yourself in financial difficulty then please seek the professional advice of an Accountant to ensure it’s not the way in which you’re running the business, but most of the time it’s simply because ‘on paper’ you haven’t earned any money but had a lot of outgoings so it looks worse than it is.