Profits and Private Companies in The Cleaning Industry

by Dr. Bart A. Basi, PhD, CPA | Published May 2026

 

 

There are big differences between operating a private company and a public company. All owners of private companies should know and understand the differences. Not knowing nor understanding the differences can lead to decisions resulting in higher taxes and lower cash flow.

The accounting and tax methods required by the federal government are different for public companies than the methods that govern accounting and tax matters allowed and used by private companies. Key areas for owners and officers of private companies to understand are depreciation, entity structure, and inventory methods.

 

Depreciation

For individuals who own stock in a public company, the Securities and Exchange Commission (SEC) sets guidelines for reporting and deducting the cost of equipment owned and used in a business. Such a company often uses straight line depreciation, a method that lowers the expense deduction related to the equipment for each year and increases the profits for the company each year. Stockholders and the government favor this method as profits increase and expenses go down each year. Also, the balance sheet shows a higher net value for the company. Accordingly, investors believe that since the asset value of the company goes up, the value of the company also increases.

The private company can deduct the entire cost of the equipment used in the business in one year. This lowers the reported profit as the depreciation expense is much higher than if the company were a public company. In addition, the assets are decreased as the equipment is now on the balance sheet at a net zero figure since the entire cost of the equipment has been deducted on the income statement.

 

The Entity Structure

One might look at a private company and a public company side by side and wrongly think that the public company is worth more than the private company. But the opposite may be true. Since the private company has lowered its profits, it should pay less taxes than the public company, and its cash should also increase.

This example assumes that all other items, such as the entity structure, are the same for both the private and the public company; and the operations are also the same for both types of companies. Unfortunately, some private companies that do not have the correct entity structure will end up paying more taxes on less profits, thus negatively affecting the cash flow.

The entity structure used by most public companies is a “C corporation” entity structure. This allows the company to pay taxes at a flat rate of 21 percent. A private company usually does not use the C corp structure. As a result the private company uses a flow-through entity structure such as a “Subchapter S” structure. A flow-through entity structure results in the profits being reported on the owner’s personal income tax return and being taxed at a much higher rate than 21 percent. The tax rate could reach as high as 37 percent.

The bottom line is that almost all private companies should consider changing their entity structure to a C corporation. Such a decision usually results in a lower tax rate and a higher cash flow, with nothing of the private company showing on the owner’s personal income tax return. It is important to also note that there is no “double taxation” for private companies.

Why does a company choose a Sub S entity over choosing a C entity structure?  Generally it is the result of the company’s accounting firm not wanting to separate the business from the ownership. This reasoning may not benefit the company. Recently a very large private company was filing a sub-S structured tax return and had the owners paying a very high tax rate on the profits because the profits were reported on the owner’s personal tax returns. When questioned, the answer was that it was easier for the accountant.

Of course, if the company was incurring a loss, then it is possible that the loss could be deducted on the personal income tax return of the owners. But again, that is only if the owners have invested and/or legally loaned money to the operating company. The tax law is clear in that losses of flow-through entities, such as a Subchapter S company, can only be deducted to the extent of owner investments, and any debt where the owner is primarily liable. The company in question was showing a profit and not a loss.

 

Inventory Methods

There are multiple inventory methods that can be used for companies. To calculate the cost of purchasing inventory, a company could include all of costs involved. Such costs could be delivery costs, insurance costs, storage costs, service charges, etc. Or, a company could include some but not all of the costs. The specific inventory method applied directly affects not just the inventory cost on the balance sheet; it also affects the cost of goods sold and the gross profit, which can affect commissions for salespeople as well as the net profit of the company.

Another method that a company could apply is to add all of the current costs of replacing the inventory, especially if the costs are going up. As one owner stated, “All costs related to items and components received allow for a measured and fast response should unusual perturbations occur.” While this statement is true, the application can result in lower commissions as well as misleading business decisions regarding selling price, restocking levels, and financing. Keeping all such costs on the books until the specific inventory is sold is not wrong, but business owners should be fully aware of the effects on the company’s financial statements and their decision processes.

Suppose one owner adds all of the costs to acquire inventory to the books while a second owner decides to expense out the costs incurred in purchasing the inventory; what is the difference between the financial statements of the two companies each year?

The first owner will have a higher cost for carrying the inventory on its books, which would result in a higher asset listing on the balance sheet, a possible change in the selling price, a lower gross profit figure, and a smaller net profit when the inventory is sold. If the inventory is not sold in the same time period in which it was purchased, the profit for the company will be higher in the purchase period, since none of the costs of purchasing the inventory will be deducted until the period when the inventory is sold. And, in the second period, when the inventory is sold, the profit will go down as all of the costs of the inventory will be deducted.

The second owner will have a lower cost on the inventory, resulting in a lower sales price, and a higher reported gross profit. Also, if the inventory is not sold in the same period in which it was purchased, the second owner will make a lower profit in the first period as the costs will all be deducted. However, when the inventory is sold in the second period, the profit will be higher than the first owner as a result of the cost of the inventory for the first owner including all of the costs of the purchase of the inventory; the second owner will have just the net cost of the inventory, resulting in a higher gross profit.

Which method is the correct one? The answer is that all methods are correct. As stated above, there are multiple inventory methods. If an owner keeps some of the expenses of a purchase and adds them to the cost of the inventory, and also deducts some costs, again, this would result in a third method that will also change the end results as stated above. The key is whether or not the owners and the key people running the company are aware of the effects on the financial statements and their decision processes regarding pricing and costs of the inventory method being used.

Finally, what happens if the cost of the inventory goes up during the year? What inventory is actually sold, the inventory purchased at a lower price or the inventory purchased at the newer price, or does the company use an average cost method? All of this gives one a lot to think about.

 

Conclusion

The purpose of this article is to point out that depreciation, entity selection, and inventory methods in a private company are not the same as they are for a public company. Business owners should discuss these items with their accountant or a professional who knows the industry.  Public companies are required to use generally accepted accounting principles, GAAP, but private companies do not have the same requirements. Understand the implications to the answers received from the accountant. Business decisions dealing with these issues are not a science but an art! Know what methods your business is using and how the results affect your business decisions, which will be key to operating a successful company.

 

For more information on how the statements in this article affect your company profits and decision making, contact Bart Basi, PhD, CPA, attorney at law, and the author of this article at bbasi@taxplanning.com.