I was doing some income tax prep work for a friend of mine who is also an internet entrepreneur like many of us are or aspire to be.
I have been doing his income tax returns for a couple years now and this year I noticed a SIGNIFICANT increase in his earnings from online activities. He makes enough to make many quit their full time jobs.
What I also noticed is a consistent trend in how he manages his online earnings. That trend is consistent with my own beliefs and the approach I take in managing my online earnings.
What is that trend? Instead of spending the online earnings outside the online business or businesses, he and I favor reinvesting our online earnings back into our online business.
Building and growing a business requires spending money. Most expenses in our lives are incurred with after tax dollars, which means that we work hard doing whatever it is that we do, pay taxes on the money we earn and then use the after tax dollars to spend on things we spend on.
Income taxes are probably one of the most neglected and misunderstood concepts, at least in my experience. Many truly do not know how much they are really paying in income taxes.
But after you come to realize how much you are really coughing up in taxes, figuring out how to spend pre-tax dollars rather than post-tax dollars becomes more enticing and exciting.
Strictly speaking from a financial perspective, there are two main benefits of reinvesting your online earnings back into your business.
First, you will be able to reduce your current income tax expense. This is best demonstrated by a simple example. Let’s say your online business generates $20,000 in earnings and that you are in a 20% income tax bracket. When you file your taxes, you pay 20% or $4,000 in taxes and keep the remaining $16,000 to save or spend.
Now say you spent $250 a month to outsource some work (perhaps more content creation or building back links) which comes out to $3,000 per year. You get to deduct all $3,000 from the $20,000 earnings to arrive at a taxable income of $17,000 from your online business.
After paying 20% in taxes (or $3,400), you get to keep $13,600 of your earnings. Sure, your net take home pay or “pay to keep” is less ($16,000 vs. $13,600), but you end up paying $600 less in taxes ($4,000 vs. $3,400).
Also don’t forget that you spent $3,000 on your business’ growth, which will pay off in a larger business and higher online earnings as a result down the road. So if you think about it, not only would you keep $13,600, but you also spend $3,000 of pre tax dollars on your business’ growth, totaling $16,600 in total disposable dollars.
This is $600 more than the first scenario in which you would’ve kept only $16,000 in disposable dollars. The $600 more in disposable dollars is the result of you paying $600 less in taxes as a result of spending $3,000 on your business. It all reconciles in the end.
Second, you will experience expedited business growth. One person (You) can only do so much. When you start to hire, delegate and outsource business related tasks, you experience much faster growth than you would if you did everything on your own.
Instead of making $20,000 in online earnings today and $30,000 a couple years from now, you may be able to grow the cash flow to $60,000 in the same time period if you engage outside help.
So down the road when your business is established and at a level you had envisioned it to be or want it to be, providing you have built it in a way where you can sustain it without as much outside help, when you stop spending on outside resources at some point down the road, you will start realizing a healthier cash flow.
Basically, you get to keep the earnings that don’t spend on salaries or outsourcing fees. But now your online earnings are much larger than what they would’ve been had you not hired help to begin with.
Although focused mainly on online earnings, the premise of this post applies to all businesses in general.
I realize that the message I am trying to convey in this post may not resonate with everyone. That is because some are in a position to be making a full time income from their online business, while others are earning money online while maintaining full time jobs.
When you are solely relying on your online business, you have to think about paying your bills and feeding your family first before reinvesting back into your business. However, if you have a successful career or a stable job and are making money online on the side, reinvesting your earnings back into your business is the best thing you can do assuming you have no other pressing financial commitments and obligations.
Which category do you fit in? What are you doing to make that dollar go farther? Do you have any suggestions for our readers on how to better manage and use their earnings from online endeavors?
Here is a relevant post on minimizing income taxes on your online earnings.Previous: The Perfect Recipe to a Healthy Financial Life