Choosing when to start your fiscal year is one of the first things you need to do when setting up a new business. It may sound like the easiest thing to do, but this small step has a big impact.
Choosing when to start your fiscal year is one of the first things you need to do when setting up a new business. It may sound like the easiest thing to do, but this one small step definitely has a big impact.
Among other things, your fiscal year will dictate your business strategy and your income tax return filing timeframe. It will determine how you track your company's financial status and how you report it to your shareholders. A strategically planned fiscal period can also improve your operations, help you cut costs and make your company attractive to potential investors.
How do you decide when to begin your fiscal year?
First, let's review what a fiscal year is and take a look at the factors that affect it.
What is a fiscal year?
A fiscal year is a period of 12 months over which you track your company's financial situation. Its start marks the point at which you begin your company's annual financial records. At the end of this 12-month period, you have a year's worth of financial data that you can use to determine your taxes and your business's financial health.
Unlike a regular year, a fiscal year doesn't have to start on January 1 and end on December 31. You can choose to start it at any point, as long as it spans 12 consecutive months.
As a business owner, you get to adopt the fiscal year that makes the most sense for your company. This can either be
- The calendar year, or
- Your own fiscal year, i.e., any 12-consecutive-month period that does not end on December 31
Following the calendar year is the straightforward option, but as you'll learn, this doesn't work for all businesses and all industries. When choosing a fiscal year, you'll have to consider several factors, including the nature of your business, tax purposes, and seasonal variations in your company's activities.
While you can start it at any time, it's common practice for business owners to kick off their fiscal year at the beginning of certain quarters. However, fiscal years are usually expressed in terms of a year-end date, so you'll often hear people talk about "the fiscal year ending March 31" or "the fiscal year ending September 30."
Now that we've gone over the fiscal year definition, let's look into the factors you need to consider when deciding when to start your company's fiscal year.
Fiscal year and taxes
If you are the sole owner of your company, the Income Tax Act requires that you follow the standard tax year. The same is true if you are a shareholder in an S corporation or if your business is registered as a single-member limited liability company (LLC). If the business is a partnership, then its tax year must be the same as the tax year of the partners.
Along with sole proprietorships, partnerships, S corporations and LLCs, the fiscal year-end of personal service corporations must also follow the calendar year.
Regular C corporations may or may not follow the calendar year, depending on which is more advantageous.
While the IRS would rather have small businesses following the calendar year, they will grant permission for you to follow any fiscal year if there is a compelling reason to do so. For instance, you may choose to follow an accounting period based on the natural sales cycle of businesses in your industry.
Fiscal year and sales cycles
Almost every industry has its own unique sales patterns. For example, retail businesses tend to be busiest during Thanksgiving, Christmas and New Year holidays. In contrast, most service-based businesses have peaks and valleys throughout the year, depending on the nature of the service they provide.
If your business doesn't experience significant changes in sales volume over the course of the year, conforming to the standard calendar year should work well. However, if your business undergoes pronounced seasonal variations, you may opt for a fiscal year that follows the natural sales cycle of your industry.
Is your business the type that is taxed according to the calendar year? If the answer is no, you may choose to base your fiscal year at the end of the busiest time for your business. For example, the natural end of the business year for retail merchants is in January, after the Christmas holiday rush and the preinventory selling period. This is why retailers usually begin their fiscal year in February.
If you own home improvement or landscaping business, you probably don't have much activity during the winter months, with fewer clients minding their lawns or having the time to take on renovation projects. In this case, a fiscal year that starts in March or April is beneficial as it places your most profitable months in the first half of the year.
Front-loading your accounting year lets you put your best foot forward financially and is a huge help when applying for loans or trying to attract investors.
For the same reason, businesses that experience an uptick in sales during the summer might go with a September 30 fiscal year-end. Similarly, gyms and fitness clubs benefit from starting their accounting period during the holiday season, when health-related resolutions for the new year are top of mind.
Fiscal year and accounting
Does an accountant manage your financial statements? If you answered yes, then you may save some money by following a fiscal year that doesn't conform to the calendar year.
Accounting firms are also seasonal businesses. This type of business usually peaks during the end of the standard calendar year, when most companies traditionally close their books. This means that if you choose to wrap up your financial year at a different time, you may be able to avail of your accountant's off-season rate and save some cash.
Accountants also typically have busy seasons near the end of each quarter, so you might want to avoid those periods too.
Apart from the main ones mentioned above, business owners may also decide on a fiscal year based on these factors.
Operational convenience: So that bookkeeping, bank reconciliations and inventory run a little smoother, many companies have a fiscal year-end that coincides with the last day of the month.
Tax remittance: Many business owners plan their fiscal year to ensure that they will be able to settle their debt. This is usually done by having the company's tax filing deadline coincide with a period of good cash flow, i.e., after the company's peak season.
- Financial reporting: Most companies have a fiscal year-end that is a long way off from the date of incorporation. For example, if a business was incorporated on February 1, company principals may adopt a fiscal year-end of January 31. This is done so that the company has financial data for a full year of operations before the first fiscal year ends.
Changing your fiscal year
You may change your current fiscal year for any number of reasons. But if you do, you must also change your tax year. And this is where it gets tricky.
To change your tax year, you have to get permission from the IRS. This means filing IRS Form 1128 (Application to Adopt, Change, or Retain a Tax Year). Personal services corporations, S corporations, and partnerships may need to file IRS Form 8716 so that they can use a tax year other than the calendar year.
If you're doing this for the first time, you might want to get a tax attorney's help. The questions are numerous and complicated and you'll want to make sure you're answering everything correctly. To get approval, make sure you follow the guidelines laid out by the IRS and have a legitimate business reason for requesting the change.
Instead of having to change your fiscal year somewhere down the road, avoid the hassle by making a well-informed decision at the very start. This means doing the necessary research and consulting an accounting or tax expert before making a decision.
Questions to ask
To summarize, here are a few questions to ask when choosing a fiscal year for your company.
- How is your business organized?
- According to the IRS guidelines, what type of tax year should you be following?
- Does your business have well-defined seasons of high and low sales?
- What is your company's best quarter for revenue generation?
- What fiscal year do other businesses in your industry follow?
- Are you comfortable having an accounting period that doesn't follow the calendar year?
The way you set up your fiscal year affects every part of your business – from your financial strategy to your taxes, from your record-keeping to your business growth. But don't be daunted. Keep the questions above in mind as you figure out the best fiscal year for your business and you'll be well on your way.