What's taxable profit?

Taxable profit is the figure HMRC uses to calculate how much tax your business owes. It's your total income after the expenses and allowances HMRC permits you to deduct. For limited companies, that figure is what Corporation Tax is charged on. For sole traders, it feeds into your Income Tax and National Insurance calculation.

It's worth understanding clearly, because taxable profit and the money in your bank account are two different things. Knowing how taxable profit is calculated helps you plan for tax, manage cash flow and make confident decisions about how you take money out of the business.

How taxable profit is calculated

The starting point is your total business income for the accounting period. From that, you deduct your allowable business expenses. What's left is your taxable profit.

The basic structure looks like this:

Total income - Allowable business expenses = Taxable profit

In practice, there are usually some adjustments along the way. Certain costs you've recorded in your accounts may need to be added back because HMRC doesn't allow them as deductions.

Others may qualify for specific reliefs, such as capital allowances on equipment. Your accountant will work through these adjustments when preparing your tax return.

What counts as an allowable expense?

An allowable expense is a cost that's incurred wholly and exclusively for the purposes of your business. If a cost meets that test, it can generally be deducted when calculating taxable profit.

Common examples include:

• staff salaries and employer pension contributions;

• rent, utilities and office costs;

• software, subscriptions and professional fees;

• marketing and advertising;

• business travel;

• accountancy fees.

Some costs sit in a grey area, particularly where there's personal use involved. A mobile phone used partly for personal calls, or a home office claim, will usually only qualify for a portion of the cost.

Capital allowances

Equipment, vehicles and certain other assets are treated differently from day-to-day running costs. Rather than deducting the full purchase price in one go, HMRC provides capital allowances, which spread the tax relief over time or, in some cases, allow the full amount in the year of purchase through the Annual Investment Allowance.

Capital allowances are worth planning for, particularly if you're buying significant assets, because they can reduce your taxable profit in a meaningful way.

What taxable profit looks like for a limited company

If you run a limited company, Corporation Tax is charged on your taxable profit. The rate depends on how much profit the company makes:

• 19% for profits up to £50,000 (small profits rate)

• 25% for profits over £250,000 (main rate)

• A tapered rate applies for profits between £50,000 and £250,000

Your director's salary is a deductible business expense, so it reduces the company's taxable profit before Corporation Tax is calculated. Dividends are paid from the profit that remains after Corporation Tax, so they don't reduce the tax bill.

This is why the mix of salary and dividends matters when you're planning how to take money out of the company.

What taxable profit looks like for a sole trader

If you're a sole trader, your taxable profit is the net profit from your business after allowable expenses. That figure is treated as your personal income and taxed through Self Assessment, along with Class 2 and Class 4 National Insurance.

There's no separation between business and personal income for a sole trader, so your taxable profit feeds directly into your overall tax position for the year.

Taxable profit and cash flow

One of the most common things that catches people out is the gap between taxable profit and cash in the bank. Your business can show a healthy profit while cash feels tight, or have cash sitting in the account while profit is lower than you'd expect.

Taxable profit is an accounting figure. It reflects income earned and costs incurred in the period, regardless of when the cash actually moved. If you've invoiced a client but they haven't paid yet, that income may still appear in your profit calculation.

Because of this, it's entirely possible to owe Corporation Tax even when cash feels stretched. Planning for this as the year goes on, rather than waiting until the bill arrives, can make a real difference to how challenging the business feels to run.

Using taxable profit in your planning

Once you have a clear picture of where your taxable profit is heading, decisions become much easier. Regular management accounts can give you an up-to-date view of where profit is heading, which makes it easier to:

• set money aside for Corporation Tax as the year progresses;

• make informed decisions about salary, dividends and pension contributions;

• understand whether the business can support planned spending.

Keeping an eye on taxable profit throughout the year means there are fewer surprises and more control. Tax becomes a predictable part of the business rather than something that needs to be dealt with at the last minute.

If you'd like to understand your taxable profit position and what it means for your tax bill, we're happy to walk through the numbers with you.