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Comment by w23j

7 years ago

I'm with peteradio, I also never understand this line of reasoning.

Let's say the company has earned 1,000$ and the tax rate is 50%. Your expenses X are 100$.

So 1,000$ - 100$ = 900$. Of which 50% (450$) are tax and 50% (450$) are profit.

Now double X to 200$:

Then 1,000$ - 200$ = 800$. Of which 50% (400$) are tax and 50% (400$) are profit.

That means your profit is 50$ lower (400$ instead of 450$) then if you hadn't increased your spending?

Clearly my thinking is wrong somehow, but where?

9 comments

w23j

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aprdm  7 years ago

If you can "invest" the 1K into something that you don't get taxed, and, can give you some return then it is a win.

I remember being mentioned that the whole reason General Electrics bought a division of Alstom was to not bring the money back to US and get taxed, let's say it was 1 billion dollars and 50% tax.

Instead of getting net 500 million back to US they can keep that money abroad and invest 1 billion in another company that can net more than 500 million in the long term.

Above is likely the way of thinking for those sort of occasions.

jkulubya  7 years ago

It should be a choice between spending pre tax dollars or spending post tax dollars. I doubt many would argue in favor of “burning” money just for the sake of not paying some fraction tax on it.

Imagine that you must access $100 of labour/whatever somehow.

  $20000 - sales
  ($10000) - cost of sales
  ——————
  $10000 - gross profit
  ($100) - extra labour paid for with pre tax money
  ——————
  $9900 net
  ($4950) tax
  ——————
  $4950 ending sum (pay dividends or do whatever you feel like with this)

vs

  $20000 - sales
  $10000 - cost of sales
  —————
  $10000 - gross profit
  ($5000) - tax
  —————
  $5000 - after tax profit
  ($100) - extra labour, post tax money
  ————
  $4900 - ending sum

It’s a bit unrealistic because (1) labour should always be pre tax (2) there are rules about what goes where in an income statement and you can’t just decide to put stuff where you want but there is some flexibility.

In particular, the one easily controllable lever is how much interest you pay on debt (pre tax spending)

pbourke  7 years ago

Think of it this way: the “cost” to realize a net profit of $450 is a tax expense of $450. What if you could reinvest that full $900 so that next year your revenue and income are higher? High-growth businesses will optimize for reinvesting because they expect the Return on investment to be higher than the return on realized profit going forward.

This is what Amazon has done for years - it generates a monstrous amount of cash (free cash flow) from retail and funnels it back into expanding current businesses and creating new ones such as AWS. AWS now generates its own surplus, so the cycle continues.

Edit to clarify: Amazon in the past has shown a relatively small net income vs large top line revenue because most cash is reinvested. It’s been a few years since I paid attention to their financials so things may be different now.

nightski  7 years ago

It doesn't make sense in terms of raw profit, I agree. But many expenses are paid pre-tax effectively making them cheaper than if you had paid for them with post-tax dollars.

ppiuser  7 years ago

What matters in your example is where that extra money is spent, you might try to invest it in the company by purchasing new machinery rather than just wasting it on a new luxury company car (or an overseas 'business meeting'). That way if you are making a 10% return on your company/investment each year it continues to grow.

lone_haxx0r  7 years ago

I guess in some situations you can either pay $1 in taxes or burn $1. it's probably better to burn $1.