2 Important Lessons For Small Business Owners

By Lewis Humphries | April 05, 2012 AAA
2 Important Lessons For Small Business Owners

Small and independent businesses in the U.S. find themselves facing an unusual challenge in the current economic climate. According to the Small Business Administration (SBA) there were more than 27 million independent businesses in operation during 2011, and these organizations were credited with creating between 60% and 80% of all jobs nationwide. Despite this, it was also estimated that 49% of these entities faced the prospect of failing during the first five years of trading. For small organizations, it is clear that a core understanding of basic business principles is key to their success, especially in relation to the clear distinction between generating turnover and profit.

How Operational Costs Influence Profit
While turnover relates to the amount of revenue that a company generates through sales, profit is the sum that is remaining after costs and corporate taxes have been deducted. Even if a company is earning millions of dollars in turnover every single year, if they have high operational costs or significant levels of debt within the business then they may still be making a financial loss. However, if an organization can control its costs in the process of generating turnover, then it will maximize its potential to make a profit.

It is well known that certain industries create higher profit margins than others, and this is largely due to the individual products that are sold within each. For example, the pharmaceutical industry in the U.S. has been known to record mark-ups of anywhere between 200% and 5,600% on individual units, with prescription drugs costing only cents to make and hundreds of dollars to buy. The cosmetics industry is also known for making significant profit based on individual item sales, and this further emphasizes the importance of cost control in maximizing profits.

Corporate Taxes
Aside from operational and manufacturing costs, corporate tax is another significant drain on any businesses turnover. Imposed at both federal and state level, the rate of corporate tax that each individual company pays is determined by its categorization and the amount of net income that it declares. So, organizations will pay different rates depending on whether they are sole proprietorships or corporations, while the money that they generate through the course of trading is also a consideration.

While there are existing tax loopholes and special dispensations for different types of business operating within the U.S., the official rate of federal and state corporate tax stands at 39.2%. With Japan reducing its own rate of corporate tax to 36.8%, the U.S. will earn the distinction as the nation with the highest tax rate in the world. This is something of a concern for emerging small businesses and start-ups, and goes a long way to explaining why both Democratic and Republican representatives are proposing radical and transparent tax reforms.

The Best Practices for Small Businesses
With these factors in mind, small businesses in the U.S must be extremely wary if they are looking to make their operation a profitable one. Although Intuit estimates that the average cost of generating a start-up business in the U.S. stands at just $325, it is the investment in product design and manufacturing that can significantly hinder a company's drive to maximize its turnover. This is why budgeting in exact dollars and cents is so crucial for small and independent businesses, both in terms of driving production costs down and delivering accurate profit projections for the future.

According to the Congressional Budget Office, total corporate federal taxes also accounted for more than 12% of U.S. profits during 2011. Given this and the fact that the current tax system is unnecessarily complex and vulnerable to creative accounting, small businesses must strive to ensure that they are as informed as possible when starting their ventures. They can not afford to be naive in terms of annual liability, and must also seek out expert advice to ensure that they are classified correctly and afforded an appropriate tax code.

The Bottom Line
Small businesses remain key to the growth of the U.S. economy, but their desire to become profitable is vulnerable to high operational costs and decidedly complex corporate tax legislation. For independent organizations to retain a significant percentage of their turnover they must minimize the cost of designing and manufacturing their core products, as profitability starts with the amount of money made on each individual unit sale. Similarly, it is crucial that they develop a clear understanding of their own corporate tax liabilities, and do not leave themselves at the mercy of ignorance or poor financial planning.

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