Why would a small business use a fiscal year?
Small businesses usually first start thinking about the fiscal year for two reasons:
- They want to do their accounting and generate their first set of financial statements (e.g. because they’re in the process of applying for a loan).
- They’re filing their first business tax return and have the option of becoming a fiscal year taxpayer.
Businesses that experience obvious high and low periods during the year will sometimes adopt a fiscal year instead of sticking to the standard calendar year. This is especially if:
- It better captures what’s going on with their business and makes it look better on paper
- It makes financial planning easier
- The business has a lot of inventory
Adopting a fiscal year is a complicated decision that should almost certainly be left to your accountant. In this guide we’ll stick to what you are and aren’t allowed to do, tax-wise, and give you some general tips about how to approach this decision.
The fiscal year and taxes
Many small businesses first start thinking about the fiscal year when it comes time to file their first business tax return.
If you’re a C corporation, the IRS lets you choose between the standard calendar year or your own fiscal year schedule.
If you’re a sole proprietor, partnership or an S corporation, you need to get permission from the IRS before adopting a fiscal year.
Filing as a calendar year taxpayer
To become a calendar year taxpayer, all you have to do is file your business tax return by April 15th following the year for which you’re filing.
If you’re a C corporation, switching from a fiscal year to the calendar year is also straightforward: all you have to do is file on April 15th following the year for which you’re filing.
Filing as a fiscal year taxpayer
If you’re a C corporation, have never filed a return for your business and have decided to use your own fiscal year, file your return on or before the 15th day of the fourth month after the last day of your fiscal year. For example, if your fiscal year ends June 30th, you must file by October 15th.
If you filed your last return using the calendar year and want to switch to a fiscal year, or you run a sole proprietorship, you have to get IRS approval to use a fiscal year by filing Form 1128.
If you run an S corporation or a partnership, you’ll have to file Form 8716 to switch to a fiscal year.
How do I pick a fiscal year end?
If you haven’t picked a fiscal year but don’t want to stick to the standard calendar year, accountants will usually tell you to pick the day you finish your natural business year. This is when your company has finished the bulk of its business for the year and activity is at its lowest.
Identifying your natural business year
Businesses that are seasonal usually have really obvious natural business years, while businesses that don’t experience high or low periods don’t.
Industries that have natural business years that are different from the calendar year include:
- Schools and universities, which usually pick a fiscal year that corresponds with when classes are in session: from July 1 to June 30th, for example.
- Nonprofits, which will often time their fiscal year to coincide with grant and award deadlines.
- Retail, which places the end of their business year after Christmas, when holiday sales subside and inventories are at their lowest.
- Agriculture, whose natural business year will usually end after the year’s biggest harvest.
Fiscal year vs calendar year: which one is better for my business?
If the end of your natural business year isn’t obvious, a fiscal year might still be better than the standard calendar year.
Remember, this isn’t just a tax consideration: picking an appropriate fiscal year could also make life easier for you, your accountant, your investors, and your creditors.
For management purposes
Picking a fiscal year can be particularly important if your business carries a lot of inventory.
Your fiscal year should end at the time of the year when inventory is lowest—so there’s less to count—and when slow-moving inventory is easiest to spot. Catching up on things like accounts receivable, returns and outstanding balances is also easier when business is at a low point.
Ideally, the end of your fiscal year should coincide with the time of the year when you have the most spare time. This is so you can afford to take a step back from the business and do long-term planning, sign new contracts, create budgets, etc.
December 31st might happen to be that day for your business, but for many businesses it isn’t.
For accounting purposes
Since many businesses use the standard December 31st year end, accounting itself is a seasonal business. Picking a fiscal year end that is different from December 31st could spread the work out and make life easier for your accountant, and also potentially save you money.
Creditors and investors
Picking a fiscal year that aligns with your natural business year can also make your business look better on the financial statements you hand over to investors and creditors.
The end of your natural business year is usually the time when you’re most likely to have converted your inventory to cash, and your current ratio is at its maximum (i.e. when you’re at your most liquid and capable of paying your debts).
Picking a fiscal year might make it easier to measure your performance against businesses in your industry, especially if they also don’t follow the standard calendar year.
So what should I do?
In 2011, the Financial Times found that 65% of publicly traded companies in the United States used the standard calendar year. If you and your accountant can’t identify an obvious, natural year end for your business, you might be better off sticking with it as well.
If your business does experience sales cycles and the natural low period doesn’t fall on December 31st, picking a fiscal year could be well worth your while.