Most of us have a simple, relatively accurate understanding of the concept, “Profit.” When you sell an object to someone for more than it cost you the extra money earned is your profit. The difficulty comes in understanding what things really cost. Without an accurate understanding of your costs you can not know what your profits really are or even if you’re making a profit at all.
[Before continuing I must stress that I’m discussing money. You can profit from experiences in non-tangible ways, but those profits are not subject to tax. For instance, I may not profit much from the sale of my writing financially, but emotionally, intellectually, and even socially, I can find it lavishly rewarding.]
The quickest way to learn about the costs of being a self-employed potter is to get a blank “Schedule C” federal income tax form and to read the corresponding explanations in the tax code. Imagine that you were in business as a working potter all of last year. Make up some numbers. Say you made and sold 2,000 pots for ten dollars apiece. Each pot used two pounds of clay, purchased pre-mixed wet at twenty cents per pound. So, you spent $800 on clay and got paid $20,000 for it. It might seem like a profit of $19,200, but it’s not.
Calculate equipment costs, studio rent, utilities, glaze materials, mileage to and from sales, overnight travel expenses and meals, display equipment, packing materials, booth fees, license fees, commissions, etc. One of the odd things here is that the wages you pay any employees count as costs but you, as the owner, get no wages. You have to live off of profits and you won’t know if you’ve made a profit at all until the year is over. If you have made a profit, those profits will be taxed 15%, for Social Security (employer and employee contributions combined) and taxed under the normal rates of the tax code. Your $20,000 gross income is not going to amount to much in the end, but if you’ve been efficient (and live frugally) it might be enough.
On the other hand, what if you can double production? Four thousand pots at ten dollars apiece might be more profitable. Equipment and rent costs might remain the same, but firing costs and materials costs will go up. What if you can’t sell four thousand pots? Perhaps you get stuck with a thousand unsold pots or you have to spend extra on advertising and extra travel. It’s not as easy as “sell more, earn more.” Unsold inventory increases your costs without increasing your income.
What if instead you double your prices? Now, two thousand pots bring in $40,000. All profit, right? Wrong. What if higher priced pots don’t sell as readily? Again, you’re back to spending money on advertising, travel, higher booth fees for more expensive Fairs, better looking display equipment and tentage. And you can’t really predict any of it with much accuracy.
Is profit impossible? No, just complicated. In fact, profit is possible in some unexpected ways. For instance, the Schedule C allows for a standard mileage rate for vehicle travel. It varies from year to year, but say they allow thirty cents per mile as the expense rate for travel. In other words, for tax purposes you are presumed to spend thirty dollars every time your business use vehicle travels one hundred miles. But you may well drive a less expensive vehicle. It is to your advantage to do so. The tax law rewards you for minimizing waste by allowing you to pocket the difference between your expense and the standard allowance.
At this point you may also wonder if being profitable is all that wonderful. After all, higher profits just mean higher taxes and who’s to know just how much cash you received at all those Fairs last year? Cheating may be a strong temptation. But consider this….
One, the IRS is inherently mistrustful of businesses that take in cash for just this reason. If you are ever audited, they will likely find your cheating out and deal with you accordingly.
Two, you must make a profit every now and then in order to be considered a business at all. Without business status your enterprise becomes a hobby. Your gross income gets taxed as pure income and your costs are just your own damn problem.
Three, when you go to the bank for a vehicle or equipment loan they will judge your income, your ability to re-pay the loan, from your previous year’s tax return. You need for it to be as strong as the facts entitle it to be.
Four, the 15% tax that goes to Social Security may be the closest thing you’ll ever have to a retirement plan. Why cheat yourself by under-reporting? If you actually invested the cash you’ve been skimming into some other retirement scheme you might be ahead of the game but then you’ve made it easier for the IRS to find your fraud.
Five, if you’ve made enough profit to have to pay significant Income and Social Security taxes, congratulations! It means that you’ve found success where so many others have failed. You have a good product, priced and marketed well, and your costs are reasonable. You’re in a position to build on this success, expand profitably, and do better next year. You’re figuring it out. Use some of those excess profits to invest in better equipment and facilities, or to expose your work to new markets. Build your business into something you can sell to someone else (profitably) when you eventually decide that you want to retire.
To calculate profit you need to consider price, volume, and cost. What was profitable yesterday may not be so tomorrow. Learn to examine your own business with the exactness you normally save for judging teapots and dinner sets. And if your boss proves to be a slave-driving unrelenting son-of-a-bitch, well, that can sometimes be the price you pay for being self-employed. Remember, too, that not all profits are monetary. Those are just the ones that get taxed. You can count your blessings without having to use a calculator or a government form.
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