EMAIL NEWSLETTER JUNE
2006
Welcome
again to the McLean
and Co. Newsletter
in which we discuss current taxation and business matters. We trust
you find it informative. Any feedback would be welcomed.
McLean
and Co. is a
home based chartered accountancy practice based in Clive, Hawkes
Bay.
Readers are invited to peruse the practice website
www.mcleanandco.co.nz,
which lists
services
provided, gives contact details and indicates how to become a client, contains
an extensive base of articles on business and taxation matters, and has
links to other websites that may assist your business. Being a
small firm itself, McLean and Co. strives to provide a personal and
professional service largely to a self employed person and small business client
base. Enquiries are welcomed.
We
are happy to accept new clients. Please contact ourselves at the contact
points highlighted above if we can assist you in your accounting and taxation
requirements. Our website lists information required for this in the following
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INDEX
-
Inland
Revenue Department Confirms Stand on Rental Property Depreciation.
-
Tax
Discount for New Businesses
-
Non
Filing of Company Returns
-
How
Much Should You Charge for your Product or Service?
-
Four Models for Calculating your Pricing
INLAND REVENUE DEPARTMENT CONFIRMS
STAND ON RENTAL PROPERTY DEPRECIATION
Inland Revenue advised on 29 May 2006 that it considers it is unacceptable for residential
rental property owners to break up their properties into smaller components in
order to get higher depreciation rates for tax purposes.
"In the past, we have disallowed the higher depreciation claims and,
after consideration by the Adjudication and Rulings business group, we
continue to believe this practice is not acceptable," says Naomi
Ferguson, Deputy Commissioner Service Delivery.
"Property owners are still able to depreciate chattels such as
carpets, drapes, light fittings, whiteware and so on, as separate assets.
There is also provision to depreciate separately items such as water heaters,
clothes lines and other fittings that are not part of the building," says
Miss Ferguson.
The items that Inland Revenue does not believe to be separate assets are
internal walls, doors, electrical wiring and plumbing and so on, as well as
furniture and fittings that are permanently attached and are regarded as being
part of the building. These include items such as kitchen cupboards,
bathroom vanities and built-in wardrobes.
Some residential property owners have been splitting these components out
and depreciating them as separate assets in order to take advantage of
higher depreciation rates listed under the "Building Fit-out (when in the
books separately from building cost)" asset category.
"Property owners who have been splitting these components out from the
cost of the building will have overstated their depreciation claim in the
past, but we won't be asking them to adjust previous years' income," says
Miss Ferguson. "However they will be required to add the value of the
various 'components' they have been depreciating individually into the cost of
the building, and combine the depreciation claimed for those individual
assets."
This will identify the asset to be depreciated, the cost of that asset and
the depreciation claimed to date. The building should then be used to claim
depreciation at the correct rate. This will depend on the type of building and
when it was acquired.
Property owners with cases still under investigation or going through the
disputes process may be able to apply this approach from the first period not
under dispute or being investigated. "A tax payer may, of course, decide
not to settle and to take the matter through the disputes process if they do
not agree with the Commissioner's treatment," says Miss Ferguson.
An Interpretation Statement on this ruling is being prepared for public
consultation.
TAX DISCOUNT FOR
NEW BUSINESSES
New business people are now able to get a tax discount for any voluntary
payments they have made over the last financial year.
"The new discount is to encourage people to get a "head
start" on their tax payments by making voluntary payments during a year
when they're not obliged to pay provisional tax," says Naomi Ferguson,
Deputy Commissioner Service Delivery.
"People who have just started in business, either self-employed or
in a partnership, don't need to start paying provisional tax until their
end-of-year tax exceeds $2,500. However, if they make voluntary payments
before they need to start paying provisional tax they can claim the discount
and get ahead with their payments."
Voluntary payments were introduced in the 2005-2006 tax year and this is
the first year people will be able to claim the discount when they file their
returns. The discount is 6.7% of the total voluntary payments made during the
year or 105% of the end-of-year tax amount - whichever is smaller. The
discount can be claimed either in the first year of business or a following
income year as long as it is before provisional tax payments start therefore
the biggest benefit will come from claiming it in the year with the highest
end-of-year income tax.
Voluntary payments can be made at any time through automatic payments,
direct credits, online banking, post (cheque only) or at any Westpac bank.
For more information on the tax discount for new businesses, or voluntary
payments, visit the IRD website or phone Inland Revenue (toll-free) on 0800 377
774.
NON FILING OF
COMPANY RETURNS
The National Compliance Unit of the Companies Office is responsible for
monitoring all companies required to file an annual return under Section 214
of the Companies Act 1993 (“the Act”).
Several notices of impending or overdue annual returns are sent to the
company’s registered office, address for communication, and every
director.
If companies fail to file annual returns, the Registrar gives notice
under section 320 of the Act and advertises his intention to remove the
company from the Register in the New Zealand Gazette and a local newspaper.
The Registrar also gives notice to people who have a security interest
registered against the company in the Personal Properties Securities
Register (PPSR) that the company may be removed.
The public have the ability to lodge, within a specified period, an
objection to the removal of a company advertised. The grounds for
objecting are set out in section 321 of the Act. One of the grounds
for objecting is that the company is still carrying on business (section
321(1)(a)). Any objection to the removal of a company must specify
which ground is being relied upon.
The Registrar also informs IRD of all companies which have
been advertised for removal. IRD reviews the list of
companies and identifies those companies with outstanding tax affairs.
Inland Revenue then lodges an objection with the Registrar (stating the
relevant ground) and removal action is ceased. These objections are
reviewed every six months and IRD confirms whether the objections
continue to be valid.
It may be some companies are deliberately failing to file their annual
return as a way of removing the company from the Register. If this is
the case, directors should be aware if the company’s tax affairs are not
in order, IRD will object to its removal. It is, therefore,
important that if a company is to be removed from the register, that you
contact IRD on 0800 377 774 in advance to confirm that the
company’s affairs are in order and to ensure no objection will be
lodged to its removal.
Alternatively, a formal removal process exists under section 318 (1) (d)
of the Act, requiring the completion of a prescribed form and written
confirmation from IRD that it does not have an objection to the
company’s removal from the Register.
HOW MUCH SHOULD
YOU CHARGE FOR YOUR PRODUCT OR SERVICE?
One of the most difficult, yet important, issues you must decide as an
business owner is how much to charge for your product or service. While there is
no one single right way to determine your pricing strategy, fortunately there
are some guidelines that will help you with your decision.
Before we get to the actual pricing models, here are some of the factors
that you need to consider:
 | Positioning - How are you positioning your product in the market?
Is pricing going to be a key part of that positioning? If you're running a
discount store, you're always going to be trying to keep your prices as
low as possible (or at least lower than your competitors). On the other
hand, if you're positioning your product as an exclusive luxury product, a
price that's too low may actually hurt your image.
| Demand Curve - How will your pricing affect demand? You're going
to have to do some basic market research to find this out, even if it's
informal. Get 10 people to answer a simple questionnaire, asking them,
"Would you buy this product/service at X price? Y price? Z
price?" For a larger venture, you'll want to do something more
formal, of course -- perhaps hire a market research firm. But even a sole
practitioner can chart a basic curve that says that at X price, X'
percentage will buy, at Y price, Y' will buy, and at Z price Z' will buy.
| Cost - Calculate the fixed and variable costs associated with
your product or service. How much is the "cost of goods", i.e.,
a cost associated with each item sold or service delivered, and how much
is "fixed overhead", i.e., it doesn't change unless your company
changes dramatically in size? Remember that your gross margin (price minus
cost of goods) has to amply cover your fixed overhead in order for you to
turn a profit. Many business owners under-estimate this and it gets them
into trouble.
| Environmental factors - Are there any legal or other constraints
on pricing? Also, what possible actions
might your competitors take? Will too low a price from you trigger a price
war? Find out what external factors may affect your pricing. |
| | |
The next step is to determine your pricing objectives. What are you trying to
accomplish with your pricing?
| Short-term profit maximization - While this sounds great, it may
not actually be the optimal approach for long-term profits. This approach
is common in businesses where cash flow is the
overriding consideration. It's also common among smaller businesses hoping
to attract funding by demonstrating profitability as soon as
possible.
| Short-term revenue maximization - This approach seeks to maximize
long-term profits by increasing market share and lowering costs through
economy of scale. For a well-funded company, or a newly public company,
revenues are considered more important than profits in building investor
confidence. Higher revenues at a slim profit, or even a loss, show that
the company is building market share and will likely reach profitability.
Amazon.com, for example, posted record-breaking revenues for several years
before ever showing a profit, and its market capitalization reflected the
high investor confidence those revenues generated.
| Maximize quantity - There are a couple of possible reasons to
choose the strategy. It may be to focus on reducing long-term costs by
achieving economies of scale. This approach might be used by a company
well-funded by its owners and other "close" investors. Or it
may be to maximize market penetration - particularly appropriate when you
expect to have a lot repeat customers. The plan may be to increase profits
by reducing costs, or to upsell existing customers on higher-profit
products down the road.
| Maximize profit margin - This strategy is most appropriate when
the number of sales is either expected to be very low or sporadic and
unpredictable. Examples include custom jewelry, art, hand-made motor
vehicles
and other luxury items.
| Differentiation - At one extreme, being the low-cost leader is a
form of differentiation from the competition. At the other end, a high
price signals high quality and/or a high level of service. Some people
really do order caviar just because it's the most expensive thing on the
menu.
| Survival - In certain situations, such as a price war, market
decline or market saturation, you must temporarily set a price that will
cover costs and allow you to continue operations. |
| | | | |
FOUR MODELS FOR
CALCULATING YOUR PRICING
There is no "one right way" to calculate your
pricing. Once you've considered the various factors involved and determined
your objectives for your pricing strategy, now you need some way to crunch
the actual numbers. Here are four ways to calculate prices:
| Cost-plus pricing - Set the price at your production cost,
including both cost of goods and fixed costs at your current volume,
plus a certain profit margin. For example, your widgets cost $20 in raw
materials and production costs, and at current sales volume (or
anticipated initial sales volume), your fixed costs come to $30 per
unit. Your total cost is $50 per unit. You decide that you want to
operate at a 20% markup, so you add $10 (20% x $50) to the cost and come
up with a price of $60 per unit. So long as you have
your costs calculated correctly and have accurately predicted your sales
volume, you will always be operating at a profit.
| Target return pricing - Set your price to achieve a target
return-on-investment (ROI). For example, let's use the same situation as
above, and assume that you have $10,000 invested in the business. Your
expected sales volume is 1,000 units in the first year. You want to
recoup all your investment in the first year, so you need to make
$10,000 profit on 1,000 units, or $10 profit per unit, giving you again
a price of $60 per unit.
| Value-based pricing - Price your product based on the value it
creates for the customer. This is usually the most profitable form of
pricing, if you can achieve it. The most extreme variation on this is
"pay for performance" pricing for services, in which you
charge on a variable scale according to the results you achieve. Let's
say that your widget above saves the typical customer $1,000 a year in,
say, energy costs. In that case, $60 seems like a bargain - maybe even too
cheap. If your product reliably produced that kind of cost savings, you
could easily charge $200, $300 or more for it, and customers would
gladly pay it, since they would get their money back in a matter of
months. However, there is one more major factor that must be considered.
| Psychological pricing - Ultimately, you must take into
consideration the consumer's perception of your price, figuring things
like:
 | Positioning - If you want to be the "low-cost
leader", you must be priced lower than your competition. If you
want to signal high quality, you should probably be priced higher
than most of your competition.
| Popular price points - There are certain "price
points" (specific prices) at which people become much more
willing to buy a certain type of product. For example, "under
$100" is a popular price point. Meals
under $5 are still a popular price point. Dropping your price to a popular price
point might mean a lower margin, but more than enough increase in
sales to offset it.
| Fair pricing - Sometimes it simply doesn't matter what the
value of the product is, even if you don't have any direct
competition. There is simply a limit to what consumers perceive as
"fair". If it's obvious that your product only cost $20 to
manufacture, even if it delivered $10,000 in value, you'd have a
hard time charging two or three thousand dollars for it -- people
would just feel like they were being robbed.
A little market testing
will help you determine the maximum price consumers will perceive as
fair. |
| |
|
| | |
Now, how do you combine all of these calculations to come up with a price?
Here are some basic guidelines:
| Your price must be enough higher than costs to cover reasonable
variations in sales volume. If your sales forecast is inaccurate,
how far off can you be and still be profitable? Ideally, you want to be
able to be off by a factor of two or more (your sales are half of your
forecast) and still be profitable.
| You have to make a living. Have you figured salary for yourself
in your costs? If not, your profit has to be enough for you to live on
and still have money to reinvest in the company.
| Your price should almost never be lower than your costs or higher
than what most consumers consider "fair". This may seem
obvious, but many business owners seem to miss this simple concept, either
by miscalculating costs or by inadequate market research to determine
fair pricing. Simply put, if people won't readily pay enough more than
your cost to make you a fair profit, you need to reconsider your
business model entirely. How can you cut your costs substantially?
Or
change your product positioning to justify higher pricing? |
| |
Pricing is a tricky business. You're certainly entitled to make a fair
profit on your product, and even a substantial one if you create value for
your customers. But remember, something is ultimately worth only what
someone is willing to pay for it.
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