The Mechanism Behind Why Cash Flow Becomes Difficult in Years When Sales Grow

"We had our highest sales ever, yet the balance in our bank account is lower than last year."
This sense of unease is not happening because you are bad at management.

Conclusion: In years when sales grow, you will structurally run out of money.

There are three reasons for this.

1. Because payments increase before the money comes in

2. Because taxes and social insurance premiums are determined by 'last year's performance' and arrive a year late

3. Because there are years when 'this year's advance payments' overlap with those one-year-late payments

Therefore, if you increase your living expenses or investments in line with the pace of sales growth, you will be stuck the following year. What you should do in a year of growth is not to spend, but to set money aside.

Structure 1: The sales from the growth remain outside your bank account for a while

When sales grow, the payments required to support them also increase. Outsourcing costs, purchases, advertising expenses, and tool fees. These go out first.

On the other hand, payments come in later. If you close at the end of the month and pay at the end of the following month, the actual payment will arrive nearly two months later.

In other words, the sales from the growth exist for a while in the form of 'accounts receivable' (money not yet collected). Even though profits on the books have increased, they are not reflected in your bank account.

The money used to cover this difference is called working capital. The more sales grow, the more working capital you need.

Structure 2: Taxes and social insurance premiums arrive a year late

This is the most important point.

The main taxes and insurance premiums for sole proprietors are paid the following year based on that year's income. There is a gap between the 'year you earned it' and the 'year you pay it'.

What to pay and when (General rule) Income tax: By the tax return deadline of the following year (generally March 15th) Consumption tax (for taxable businesses): By March 31st of the following year Resident tax: Generally in four installments starting from June of the following year Business tax for individuals: Twice a year in August and November of the following year National Health Insurance premiums: From around June of the following year based on the previous year's income

*If the payment deadline falls on a weekend or holiday, it will be shifted to the next business day. *Detailed deadlines and requirements change depending on the fiscal year. Please check the latest information on the National Tax Agency and each local government's website.

In other words, the burden for the year when sales grew does not arrive in that year. It arrives all at once the following year.

During the year of growth, you only receive bills based on 'last year's lower income.' Therefore, at that point, it looks like you have plenty of room.

Structure 3: 'Settlement' and 'advance payment' overlap in the same year

Furthermore, there is a prepayment system.

Estimated Income Tax Payments

Individuals whose estimated tax base amount, calculated based on the previous year's figures, is 150,000 yen or more are subject to estimated tax payments. This is a system where you prepay one-third of the base amount in two installments, for the first and second periods respectively. Those subject to this will receive a notification from the tax office.

*System details, amounts, and timing are subject to change. *Source: National Tax Agency "No. 2040 Estimated Tax Payments"
https://www.nta.go.jp/taxes/shiraberu/taxanswer/shotoku/2040.htm

Interim Consumption Tax Returns

Businesses whose annual consumption tax amount for the immediately preceding taxable period (excluding national tax and local consumption tax) exceeds 480,000 yen are required to file an interim tax return. Depending on the amount of tax, the frequency of filings changes to once, three times, or eleven times per year.

*Source: National Tax Agency "No. 6609 Methods for Interim Tax Returns"
https://www.nta.go.jp/taxes/shiraberu/taxanswer/shohi/6609.htm

What these two things mean is as follows.

In the year following a year of sales growth, the "settlement for the previous year" and the "prepayment for the current year" both fall within the same 12-month period.

Specific example: When sales increase from 10 million yen to 16 million yen

Let's look at the numbers.

Assumptions (this is strictly a model case)

• Residing in Tokyo, single, enrolled in National Health Insurance, under 40 years old

• Blue return filing (applying the 650,000 yen blue return special deduction)

• Subject to individual enterprise tax for statutory business categories (assuming a 5% tax rate)

• Basic deductions, social insurance premium deductions, etc., are grouped together for convenience

• Consumption tax is not included here because it varies significantly depending on whether you are a taxable business entity or use simplified tax accounting.

Two-year figures

• Year X: Sales 10 million yen, expenses 4 million yen, business income (before blue return deduction) 6 million yen

• Year X+1: Sales 16 million yen, expenses 6 million yen, business income (before blue return deduction) 10 million yen

The burden (estimated) incurred the following year for that income

• For year X (paid in year X+1)

  • Income tax and special reconstruction income tax: approx. 380,000 yen

  • Resident tax: approx. 400,000 yen

  • Sole proprietorship tax: approx. 160,000 yen

  • National health insurance premiums: approx. 550,000 yen

  • Estimated total: around 1.5 million yen

• For Year X+1 (payable in Year X+2)

  • Income Tax & Special Reconstruction Income Tax: Approx. 1.16 million yen

  • Resident Tax: Approx. 780,000 yen

  • Sole Proprietorship Tax: Approx. 360,000 yen

  • National Health Insurance Premiums: Potential to reach the cap

  • Estimated Total: Over 3 million yen

*The above figures are all estimates. Amounts vary significantly depending on income deductions, dependents, the municipality of residence, and the type of business.
*National Health Insurance premiums have a cap (levy limit) set by each municipality. Since amounts and rates are reviewed annually, please check your local municipality's website.
*For the income tax quick reference table, see the National Tax Agency's "No. 2260 Income Tax Rates"
https://www.nta.go.jp/taxes/shiraberu/taxanswer/shotoku/2260.htm
*The business owner deduction for sole proprietorship tax is 2.9 million yen per year.
Source: Tokyo Metropolitan Government Bureau of Taxation "Sole Proprietorship Tax"
https://www.tax.metro.tokyo.lg.jp/jp/kazei/work/kojin_ji

This is where we get to the main point.

When sales increase by 1.6 times, the burden does not stop at 1.6 times. This is because income tax is a progressive tax (a system where higher tax rates are applied to the increased portion as income grows).

In the table above, the estimated burden has roughly doubled from around 1.5 million yen to over 3 million yen.

Furthermore, in Year X+2, advance tax payments also pile up. In addition to the settlement for Year X+1, the advance payment for Year X+2 arrives in the same year.

And if sales in Year X+2 were to return to the original 10 million yen,
even though your earnings have decreased, the payments arrive at last year's level.

This is the reality behind why it is said that "the year sales grow is the year it gets difficult."

Points of Caution and Exceptions

There is a system for requesting a reduction

If your income this year is expected to be significantly lower than the previous year, there is a mechanism to apply for a reduction in advance tax payments. However, you must apply within the deadline and undergo a review by the tax office. It is not guaranteed to be approved just by applying.

For interim consumption tax filings, you may be able to choose a calculation method based on actual results. Whether this is applicable or advantageous depends on the case. Please consult your tax accountant or the local tax office.

Incorporating does not necessarily solve the problem

Some people think, "Then I'll just incorporate."
However, corporations also have interim filings for corporate tax, and social insurance premiums are paid monthly. The structural gap between cash inflow and payment remains the same even for a corporation.

Taxes are not the only reason money doesn't remain on hand.
Social insurance premiums occur even if you are not making a profit.
I have summarized the culprits that reduce your take-home pay in "It's Not Taxes, It's Social Insurance Premiums."

Furthermore, incorporating incurs fixed costs separate from cash flow management.
Social insurance premiums on executive compensation, the per-capita levy of corporate resident tax that applies even in a deficit, and tax accountant fees.
If you do not calculate these, you will make the wrong decision.

The turning point for incorporation is covered in detail in another article.

※The above is a paid article (you can read up to Chapter 2 for free).

The decision to incorporate should be made comprehensively, including factors other than cash flow.
Generally, it is recommended to make the decision after conducting a simulation.

Consumption tax is yet another layer.

Consumption tax included in sales has the nature of being money held in trust. While it looks like your own money while it is in your possession, it is something that must be paid later.

Determining whether you are a taxable business entity and calculating the tax amount are complex. This point will be covered in detail in a separate article.

Next steps to take

1. Physically separate your tax payment account from your personal living account

If you keep them in the same account, you will inevitably end up spending it. Just separating them is effective.

2. Every time you receive a payment, transfer a set percentage to the tax payment account

The percentage you should set aside depends on your income level, deductions, and local government. First, try calculating it using your own figures.

3. Open the envelopes that arrive between June and August on the same day

Notifications for resident tax, estimated tax payments, and individual business tax. The mail that arrives during this period consists only of items with large amounts. Do not postpone opening them.

4. Estimate next year's tax amount once within the year

Once you enter December, the options you have are limited. If possible, it is reassuring to calculate the estimated final figures for the year during October or November. If you have a tax accountant, it is common to consult with them during this period.

An increase in sales itself is definitely a good thing. The reason it becomes difficult is not because it grew, but because there is a time lag between the year it grew and the year you pay the tax.

If you understand the structure, you can prepare for it.

Making a profit and having cash on hand are two different things.
This discrepancy becomes even more complex after incorporating.
Situations where your take-home pay decreases due to incorporation are explained in the paid article 'My Take-Home Pay Decreased After Incorporating' (¥980).

※This article provides general information and is not individual tax advice. Please confirm actual decisions with your tax accountant or the competent tax office.

Reference Links

• National Tax Agency 'No. 2040 Estimated Tax Payment'<br>https://www.nta.go.jp/taxes/shiraberu/taxanswer/shotoku/2040.htm

• National Tax Agency 'No. 6609 Method of Interim Filing'<br>https://www.nta.go.jp/taxes/shiraberu/taxanswer/shohi/6609.htm

• National Tax Agency 'No. 2260 Income Tax Rates'<br>https://www.nta.go.jp/taxes/shiraberu/taxanswer/shotoku/2260.htm

• Tokyo Metropolitan Government Bureau of Taxation "Individual Enterprise Tax"<br>https://www.tax.metro.tokyo.lg.jp/kazei/work/kojin_ji