Choosing when to begin your fiscal year is one of the first steps when starting a business. Deciding on a fiscal year start date may not sound crucial, but this small step can significantly impact your business.
Your fiscal year dictates your business strategy and income tax return filing time frame. It determines how you’ll track your company’s financial status and report it to your shareholders. A strategically planned fiscal period can also improve operations, cut costs and help you find investors for your business.
We’ll explain what a fiscal year is and explore the factors involved in choosing when to begin your fiscal year.
What is a fiscal year?
A fiscal year is a 12-month financial tracking period. Its start marks the beginning of a company’s annual financial records and accounting cycle. At the end of these 12 months, you have a year’s worth of financial data to help you file taxes and determine 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 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. You can choose from:
- The calendar year
- A custom fiscal year; i.e., any 12-consecutive-month period that does not end on December 31
Following the calendar year is a straightforward option. However, this doesn’t work for all businesses and industries. When choosing a fiscal year, you must consider several factors, including the nature of your business, taxes and seasonal variations in your company’s activities.
While you can start your fiscal year anytime, business owners typically kick off their fiscal year at the beginning of certain quarters. However, fiscal years are usually expressed as a year-end date, so you’ll often hear people discuss “the fiscal year ending March 31” or “the fiscal year ending September 30.”
Did you know? When budget planning, businesses must examine revenue and expenses for the calendar year and fiscal year, analyzing the previous year’s expenditures and projecting whether they’ll spend the same, more or less in the upcoming year.
How to decide on your company’s fiscal year
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 follow?
- 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?
To choose the best fiscal year for your business, decide on your primary goal. Some goals might include:
- Showing high profitability: If your company is seeking investors, you’ll want to demonstrate profitable growth because profits will be their primary concern. In this situation, consider starting your fiscal year as your busy season begins. The start of your year will look great to investors because that’s when you get the bulk of your business. There may be an assumption that profits at the beginning of the fiscal year will continue throughout the rest of the year.
- Having low inventory levels: If you sell products, consider starting your fiscal year after your busy season ends, when inventory is at its lowest level. You’ll have less inventory to count at the end of the year, making it easier to create your financial statements.
- Wanting time for strategic planning: Creating your next year’s strategic plan is easier if you aren’t overwhelmed with running your business’s day-to-day operations. For this reason, some companies choose to start their fiscal year after their busiest time is over. The lull gives management time to assess the previous year, research new products and vendors, and create your marketing plan and sales process for the following year.
- Having plenty of cash on hand: When you are looking to expand through borrowing or taking on investors, you want your business to appear to be in a stable financial condition. On paper, you look the strongest when your cash flow statement reflects plenty of cash in the bank. This will be after your busy season, when you’ve had your highest sales but haven’t yet reinvested in new inventory.
- Following the natural timing of your business: Some businesses have a chunk of time when they conduct most of their business and a smaller period with less business. For example, a university might choose to begin its fiscal year in August when classes begin or in June when they end to capture the revenue from each year of classes in the same fiscal year. Similarly, an agriculture business might end its fiscal year just after its harvest.
Tip: Discuss your goals with a tax expert or your accounting and finance team to determine if changing your fiscal year will benefit your business.
Factors that affect when you set your fiscal year
Consider the following factors when deciding on your fiscal year’s start:
1. Consider tax implications when setting your fiscal year’s start.
If you’re the sole proprietor 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 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, it will grant permission for you to follow any fiscal year if there’s a compelling reason. For example, you may choose to follow a financial accounting period based on the natural sales cycle of businesses in your industry.
2. Consider sales cycles when setting your fiscal year’s start.
If your business doesn’t experience significant sales volume changes over 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 taxed according to the calendar year? If not, you may choose to base your fiscal year at the end of the busiest time for your business. For example, consider the following:
- Retail businesses: The natural end of the business year for retail merchants is in January, after the Christmas holiday rush and the pre-inventory selling period. This is why, in retail accounting, retailers usually begin their fiscal year in February.
- Home improvement businesses: If you own a home improvement or landscaping business, you probably don’t have much activity during the winter months, with fewer clients minding their lawns or having time to take on renovation projects. In this case, a fiscal year starting in March or April is beneficial, as it places your most profitable months in the year’s first half.
- Summer-based businesses: Businesses that experience an uptick in sales during the summer might go with a September 30 fiscal year-end.
- Gyms and fitness clubs: 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.
FYI: Front-loading your accounting year lets you put your best foot forward financially and is a huge help when applying for a business loan or trying to attract investors.
3. Consider accounting when setting your fiscal year’s start.
Have you hired an accountant to manage your financial statements? If so, you may save money by following a fiscal year that doesn’t conform to the calendar year.
Accounting firms are also seasonal businesses. They usually peak during the end of the standard calendar year, when most companies traditionally close their books. If you choose to wrap up your financial year at a different time, you may enjoy your accountant’s off-season rate and save some cash.
Accountants also typically have busy seasons near the end of each quarter, so you also might want to avoid those periods.
4. Consider other factors when setting your fiscal year start.
Business owners may also decide on a fiscal year based on some additional factors, including the following:
- Operational convenience: Many companies have a fiscal year-end that coincides with the last day of the month. This helps bookkeeping, bank reconciliations and inventory run more smoothly.
- Tax remittance: Many business owners plan their fiscal year to ensure they can 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 a long way 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 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 various 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 must 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 to use a tax year other than the calendar year.
If you’re doing this for the first time, consider getting a tax attorney’s help. The questions are numerous and complicated, and you’ll want to ensure you answer everything correctly. To get approval, follow the guidelines laid out by the IRS and have a legitimate business reason for requesting the change.
IRS automatic approval for changing a fiscal year
The IRS will give some organizations automatic approval for changing their fiscal year. If you qualify for this, there is no fee.
To be considered for automatic approval, your business:
- Must not have changed its accounting period in the previous four years
- Must not have any interest in a pass-through entity like an LLC
- Must not have any stock in a foreign sales business
- Must not be a personal service business
- Must not be part of a consolidated group
Tip: Instead of changing your fiscal year somewhere down the road, avoid the hassle by making a well-informed decision at the start. Do the necessary research and talk to a tax consultant or accounting expert before deciding.
Your fiscal year has broad ramifications
How you set up your fiscal year affects every aspect of your business, including your financial strategy, taxes, recordkeeping and business growth. But don’t be daunted. Keep the questions, factors and advice here in mind, and consult a professional to determine the best fiscal year for your business.
Jennifer Dublino contributed to the reporting and writing in this article.