Are you starting a business or a hobby?
So you’ve decided to start a business, the first question to ask is, can I make a profit? Entrepreneurs don’t always ask this question, but they should. The purpose of a business is to increase shareholder value (make a profit), while the purpose of a hobby is to enrich our lives. Hobbies are great. Many people have turned their hobby into a viable business and may be a good place to start.
Every year there are approximately 150,000 new businesses started in Canada. Of these businesses, only 51 % will still be in business in five years. To make it to the five-year mark, your business needs to make more money than it spends (a profit) over that time. Many companies will start with a loss but, over time, will begin to make money as they grow.
In Canada, the Canada Revenue Agency (CRA) uses the following as a guide to determine if you have a business or a hobby. If the CRA determines that your new business is a hobby, they will restrict the amount and types of expenses you can deduct on your taxes.
- The profit and loss experience in past years; (e., Is this a new business or has it been around for a while).
- The amount of gross income, if any, reported over several years; (i.e., Have you made sales through your business).
- The length of time over which a profit could reasonably be expected to be shown must be relevant to the nature of the activity. For example, in the case of a tree farm, the relevant time period might be longer than a vegetable farm; (i.e., Given your type of business how long on average does it take to make a profit).
- The extent of activity in relation to that of businesses of a comparable nature and size in the same locality; (i.e., Compared to other businesses of the same type and size do you have a similar amount of sales, employees, etc.).
- The amount of time spent on the activity in question; (i.e., Do you spend time working your business or do you do it for fun).
- The individual’s qualifications, such as experience, training, and education, including his/her eligibility for membership in a professional association; (i.e., If you are offering service, are you qualified to provide it, for example, a massage therapist needs certification to operate their business).
- The qualification of the individual for public assistance given to those who are carrying on a business in that field of activity;
- The individual’s intended course of action, as evidenced by his/her efforts showing an intention to make a profit (e.g., the preparation of a business plan);
- The capability of the venture as capitalized to show a profit after charging depreciation, and the development of the operation and commitments for future expansion according to the individual’s available resources. This includes the ability to secure proper and reasonable financing to make the venture a viable business capable of showing a profit; (i.e., Do you have sufficient financial resources to ensure your business will be profitable).
- The degree of effort in promoting and marketing the products or services supplied by the individual as, for example, the registration of a trading name and the opening and maintaining books and records; (i.e., Are you actively looking for customers for your goods or services).
- The type of expenditures claimed and their relevance and reasonableness to the activity, and
- The nature of the product or service supplied, such that it has a profit potential (i.e., a market exists or can be developed).
At Arbutus Management Consulting, we can help set your business up for success.