Startup Business Mistake No. 1 – Being able to pay your “Net Wages” is not enough.
Startup Business Mistake series
This is the first in our series highlighting common startup business mistakes (though the mistake isn’t unique to startups). On this occasion we will talk about paying wages.
Payday not what it used to be
Its a funny thing when you are a business owner, payday used to be a somewhat exciting day, certainly a day almost all of us looked forward to, but that all changes when you are the business owner.All of a sudden, for most business owners, it becomes the biggest negative cashflow day of the week/fortnight or month.Just as you see your bank balance getting to a health position with regular customer payments coming in, BAM, it takes a big hit as your Team’s hard work crystalises into a due obligation (not that you begrudge them their fair pay of course).
What you “have” to pay on the day is only the starting point
As you would all know, on pay day, it is only the “Net” wages that actually need to be paid to your employees. This means you pay them their Gross Earnings LESS the tax you are required to withhold under the Pay As You Go system. That tax withheld is referred to as the PAYG Withholding (“PAYGW”).Naturally, the first priority for any business owner is to make sure there is enough cash available in the bank to pay your employees on the day and to keep them happy. Therefore it is this Net Wages figure at the front of mind. However, while this required cash outlay is easy to focus on, it is barely half the story.
On that day, your PAYGW liability has crystalised
Immediately upon paying your employees their Net Wages, you have created a liability owing to the ATO for the PAYGW. Sure, it isn’t due that day. Depending on your registration status and where the current pay period sits within the lodgement period required payment could even be nearly five months away. But there is no doubt about it, that debt is now unavoidable.
So has your Superannuation Guarantee liability
Also immediately upon paying Net Wages, you have also created a liability to the employees’ super funds (or potentially even the ATO) for their superannuation entitlement. Again, that debt is also now unavoidable (you really can’t “tax plan” out of either of these debts).
The obligations created are nearly the same amount again
The precise figures will vary from pay period to pay period, and it will vary depending on businesses and in particular the level of remuneration of your employees, however as a good guide, the PAYGW will be around 30% of your total wages bill. Of course as everyone should know, the Superannuation obligation is a further 9.5% (based on today’s rates) on top of an employees earnings (even more if you allow salary sacrificing).Between the two, that is roughly an additional 40% on top of the Net Wages paid to employees that day (and for some it could be more).
The debt adds up real quick
Of course that extra 40% obligation will add up very quickly, and it can turn into a very big number depending on your Activity Statement lodgement period. In fact, if you only lodge quarterly, and you pay wages fortnightly, you could have as many as seven pay periods all with PAYGW and Super adding to your quarter end payment obligation. And if the actual payment is not due until between 28 days and 56 days after the end of the quarter, even more pay periods will have occurred adding further to your debt before any payments have actually been made.
So, Startup Business Mistake Number 1 is …
Making the assumption on pay day that if there is enough money in the bank to meet Net Wages, things are going ok and you can continue along as is.But, if you only have enough to pay the Net Wages on that day, you are at least 40% behind the game (excluding other business expenses and overheads).So, as a guide, if you are struggling to have enough money in the bank to meet Net Wages on a regular basis, alarm bells should be ringing, because there is a very real risk your business is not generating enough revenue, or has a cashflow problem, or is not profitable, or is undercapitalised, or all of the above!
Set a Rule and Stick to it
To avoid making this startup business mistake we recommend to all our new (and existing) small business clients, aim to have enough money in the bank on every single pay day to meet all three of Net Wages, the PAYGW and the Super!And …On pay day, after paying your employees their Net Wages, pay the PAYGW and the Super into a separate bank account ready for when it needs to be disbursed to the ATO and/or the Super Funds.The second bank account should of course earn you some interest, it should also be considered out of bounds and untouchable (except maybe in extreme circumstances or emergency).This way, each pay period, if you can afford to put the funds aside as planned, you have a good indicator your business is at least going ok, and that it is not digging a hole in relation to these obligations that you can’t get out of. Further, you can rest a little easier knowing you have already put funds aside for upcoming key obligations in advance, avoiding the need to go searching for it later. Finally, it also helps avoid you living (be it in relation to business activities or personal drawings and remuneration) beyond your means!
If you fail to stick to the Rule, act straight away
If you fail to stick to the above rule over the course of multiple periods you should take that as a sign there is something wrong, and you should act on it immediately! As indicated, every pay period you can’t follow the rule is another step towards a very deep dark hole you can no longer recover from. Don’t stick your head in the sand (or down that hole), act quickly, speak to us. There are probably a number of things that can be done, that if done soon enough, can ensure the issue doesn’t get out of hand. But the longer you leave it, the longer you “hope”, the worse things will get, and the ever increasing chance the consequences will extend beyond the simple closure of your underperforming business!Failing to act when there is a very clear sign of problems is arguably startup business mistake number 2!