With apologies to the MBAs out there. But if you have totally forgotten accounting, you definitely need to know this.
Once a bootstrapper starts operations, initial expenses are small. Typically you buy laptops, desktops, hubs or switches or white boards, chairs, tables. The model is: you need something and you go pick it up from a store. As soon as you start scaling up, you will notice a strange thing when you visit your accountant. You have little money in the bank and your tax liability is more than cash you have! I was surprised the first time it happened to us and I learned about depreciation the hard way. The simplistic accounting I knew only included knowledge of cash coming in and going out. As per my definition if I would have made profits, it would have resulted in excess cash (earning minus spending) in bank from which the government is welcome to take its 30-plus%. Wish it were that simple.
Depreciation works like this – any asset you buy has a life. Since you buy a chair and can use it for the next 5 years, the government will force you to expense it piece by piece over 5 years. Lets take an example – say the chair costs Rs 100 and has the life of 5 years (government has prescribed these for various categories, so this is just an example). For simplicity, assume you only made Rs 150 in that year and all you bought was a chair. No other expenses happened. Your bank would have Rs 50 left but your tax won’t be Rs 15 (30% of 50) but Rs 39 (30% of 130). Since only Rs 20 (20% of 100 in the first year) is allowable expense and the rest Rs 80 is an asset that you have created. Fortunately, taxes are paid in in September of the following year which gives you some time to earn the money you need to give to the government. If you are a young business, most likely your revenues are going so fast that last year huge tax looks like this years change (if not, you may not be growing fast enough and maybe on your way to becoming a small business).
I will use the above lesson to practical effect in a subsequent post. Meanwhile a small tip: the government charges a 1% per month interest if you delay the tax payment by a few months. It is perfectly legal to do so. Take the offer – a bootstrapper won’t find anyone else willing to finance without a collateral at 12% p.a.
