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Chase Overdue Invoices or Push Them into the Next Financial Year?

With the end of the financial year quickly approaching, you might be trying to chase up unpaid invoices before 30th June. But could it be better to wait to recover any outstanding invoices in the next financial year?

We take you through the aspects that influence when you pay tax on your outstanding invoices. 

Accrual or Cash Accounting

Depending on your accounting method, if you have performed work for someone this financial year, the receivable may be included in your taxable income regardless of whether you’ve been paid yet. 

What is accrual accounting?

With accrual accounting, you account for income and expenses as they arise, rather than when money exchanges hands. For example, if you provide a service for a customer on 15th June and you use accrual accounting, you would record the income on 15th June. If the customer doesn’t pay you until after 1st July, the amount is still assessed as taxable income in the year you completed the job. 

If you use this accounting method, then it makes no difference to your taxable income if you chase the payment now or next financial year. However, recovering funds sooner rather than later helps manage cash flow, so if you have the time and resources to chase up the funds now, it’s probably a good idea to do so. 

What is cash accounting? 

With cash accounting, income and expenses are recorded with the incoming and outgoing of money. Consider the example above, you’ve performed a service on 15th June, but the income is only included as assessable income in the financial year that the money is received. If the invoice is paid before 30th June, the amount will be included in the current financial year, but if it’s paid after 30th June, it won’t be included until the end of the next financial year. 

If you are using the cash basis of accounting, you have the freedom to decide if you’d rather chase up invoices now or hold off to push the income into the next financial year. There are pros and cons for both sides, and they depend on factors like your marginal tax rate, expected sales for the next financial year and cash flow requirements. 

Impacts of Delaying Chasing Overdue Invoices

Falling into different tax brackets

The structure of your business determines which tax rates you pay. If your business is a registered company, you will pay tax at the company tax rate on every dollar earned. The company tax rate is 26% or 30%, depending on your turnover. If you are working as a sole trader or a partnership, your share of profit is taxed at the individual tax rate. This is where you may have the opportunity to slip into a lower tax bracket. 

The 2020/21 Australian individual tax rates are as follows:

 

Taxable Income

Tax rate

$0 to $18,200

0%

$18,201 to $45,000

19%

$45,001 to $120,000

32.5%

$120,000 to $180,000

37%

$180,001 and over

45%

 

Your marginal tax rate is the rate of tax you pay on your next dollar. For example, if you have earned $180,000 for the year, your marginal tax rate is 37%. However, your next dollar of income falls in the next tax bracket, which means your marginal tax rate would be 45% — that next dollar is taxed at 45% instead of 37%. While it’s probably not going to break the bank having to pay 45 cents for that extra dollar, if you have to pay 45% on an additional $10,000, it starts to get expensive.

Consider a business that has made taxable income of less than $180,000. They’re waiting on $50,000 of unpaid invoices. If they receive their money before the end of the financial year, they will need to pay $22,500 in tax (45%) (before considering deductions). But if they wait until the next financial year to chase the money, they can keep their marginal tax rate at 37%. 

This strategy doesn’t help you avoid paying tax — the amount will still be assessed for tax purposes, it will just be deferred to the next financial year. But it does allow you to pay a lower tax rate on those late payments in the next financial year. However, paying a lower tax rate would mean the assessable income would need to be lower than the current period. This may work for a business that is slowing down, but if you’re going through a period of growth and expansion, it may be wise to chase down your invoices in the current period — otherwise, it could tip you into a higher tax bracket if your income is significantly higher next year.

For example, Earning $120,000 means you’ll pay 32.5% tax. The next dollar would be taxed at 37%. By pushing those next dollars into the following financial year, you avoid paying 37% on it, but if you earn more than $120,000 in that period, you’ll still end up paying 37% anyway. The only way you could completely avoid paying tax would be if your business incurred a loss the next financial year — this is far from a good tax strategy, though. 

As you can see, pushing your overdue income into the next tax period could be a pro for the current period, but could turn into a con if you end up having to pay a higher rate of tax in the next period. It really comes down to the circumstances of your business.

Remaining within tax offset thresholds

There are tax offsets available for low and middle income earners. The low income tax offset is for people earning below $66,667, and the low and middle income tax offset is for people earning less than $126,000. The tax offsets can reduce your tax bill by a maximum of $1,080 (which starts reducing after $90,000), so it’s nothing to be sneezed at! 

To stay below the threshold, the same principles apply as the above example with the tax brackets. To be eligible for an offset of $1,080, you’d need to keep your taxable income to less than $90,000. So if you have outstanding invoices that will push you over the threshold, it might be worth waiting a few weeks before chasing them up. 

Cash flow issues

If you don’t have enough cash on hand to keep up with the operating expenses of your business, it is essential to chase your unpaid invoices to ensure timely payment. Lack of cash flow is a key contributor to the failure of many businesses, so it’s important to have an understanding of how much liquidity you need. 

Invoice finance

If you have a large amount of unpaid invoices and you’re noticing problems with cash flow, such as not having enough money to pay your staff on time or purchase new stock, cash flow finance can help close the gap between issuing an invoice and being paid. You borrow an amount of money based on your unpaid invoices, which is repaid once your customers fix up their bill. It’s an efficient way of ensuring your cash flow needs are covered. 

Tips for chasing overdue invoices

Generally speaking, it’s a good idea to chase up your invoices early on to avoid the risk of non-payment. Here are some tips on how to chase overdue invoices:

  • Automated overdue invoices email. Be consistent with your process. Set up a series of automated emails to touch base with your customer periodically. For example, five days after the due date, ten days later and 15 days later. Your bookkeeping software may even have templates you can use. 
  • Discuss overdue invoice via phone call. After your emails have been sent out, it’s time to follow up with a phone call. Your customer may bring to your attention that they’re suffering from financial hardship. This is your opportunity to offer alternative payment terms such as an instalment plan. 
  • Overdue invoices letter of demand. If you still have not received payment after the first two steps, it’s time to send a letter of demand. There are many good letter of demand templates available on the internet — often, when people see the threat of legal action, they’ll make their payment promptly. 

If these steps fail, you may need to consider using a debt collector or legal action. 

If you’re thinking about taking a break from following up invoices to push the income into the next financial year, it may work in your favour by reducing your taxable income in this tax period. However, it’s generally best to keep on top of receiving your payments to avoid non-payment risk and cash flow issues.

 

Comprehensive tax strategies plan for more than just your current financial year, so it’s a good idea to speak to your accountant about your tax planning for not just this EOFY, but for future financial years — especially to get advice relating to your personal situation. While we know a few tricks, it certainly isn’t intended to be taxation advice. If you’re wondering how these tips might work for your business, have a chat with your adviser or trusted financial professional.

 

If you'd like to learn more about invoice finance or equipment finance with Earlypay, please visit us at earlypay.com.au, call our friendly team on 1300 760 205 or contact your broker or BDM.

 

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Topics: Invoice Finance