1. Cash flow is as important as profit
Cash is and will forever be, King. Profit and loss statements are a great tool for monitoring the ongoing success of the business and whilst a healthy profit before tax number can provide a great stress reliever (or stress inducer if the opposite is true), these need to be viewed in conjunction with the real measure of the business’ success - its ability to meet its payments as and when they fall due and still have excess cash in reserve.
For example, if your profit and loss statements show a net profit, but you have significant creditors outstanding, the chances are your business is on shaky ground, notwithstanding the strong profit figures.
One of the most valuable functions in a small business is accounts receivable – do not neglect it. Earning the income is only half the story, you still need to collect it. There are a number of scenarios where that income may never be collected, including customers going into liquidation, bankruptcy, simply disputing your invoices and/or the services you provided. Settling disputes is often a costly and stressful exercise and may involve a legal or court process.
The business should also be adequately financed and fully supported, where appropriate, by their bank or shareholders. Expecting a business to run efficiently solely out of the free cash flow of the business with no serious injection of capital is a risky proposition. There will likely be numerous times where the business has a cashflow shortfall and requires short-term support from its lenders. Trading insolvent is not only illegal, but a key indicator of a fledgling business. Get the bank on your side and always have a well-capitalised business.
2. When cash is tight, do not forgo or delay payments to the ATO
Tax liabilities such as PAYG, GST and superannuation are regular payments businesses incur every month. When cashflow is tight, there is a natural tendency to withhold or delay payments to creditors, and the ATO is usually the first as it is assumed there are no real consequences as long as payment is eventually made.
This is a very bad mistake. The ATO is the only creditor you will have that is able to shut you down, and whilst this maybe an extreme example, can and does occur. They have the power to garnish money from your bank accounts and in the case of PAYG and superannuation, the liability can be put on the Directors personally. No other creditor has these powers, including secured creditors such as banks. Whilst their recovery action has been temporarily halted due to COVID, these measures have now started to return to normal and will be enforced in a less lenient manner than the past year.
If it is necessary, it would be far better to discuss payment arrangements with your other creditors than delay payments to the ATO. Most businesses are accommodating and there are even number of payment platforms now that allow you to pay your suppliers over time with your supplier still being paid up-front (Quickfee is a good example).
If you are constantly having to delay payments to the ATO (or to any creditors) it is likely a sign your business is in real stress. Additionally, if you cannot understand why you are always short on cash when your business is supposedly making healthy profits, it could indicate a problem with your accounting system or bookkeeping procedures.
3. Set aside cash in separate accounts
If you are in the enviable position of having excess cash, you may want to consider setting it aside in separate accounts to ensure there are enough funds to meet future ongoing liabilities (such as tax liabilities and employee wages).
Often the excess cash is only temporary and by keeping your excess cash in your main operating account, there is a risk that it gets spent unnecessarily and you're left unable to pay upcoming liabilities. In this situation, paying staff bonuses or dividends to shareholders is common, as well as making large capital equipment purchases.
Parkinson’s Law is one of the best known and the most important laws of money and wealth accumulation. This law says that, no matter how much cash you have, you tend to spend the entire amount. In other words, your expenses rise in lockstep with the earnings.
By keeping excess funds in a separate account, you eliminate this illusion, ensure that you are able to meet ongoing cash payments and are less likely to make unnecessary purchases that the business cannot afford (and in doing so, undo your hard work).
4. Be honest and make provisions for future liabilities
Unused annual leave, long service leave, and company income tax are all legitimate, real expenses that exist but because they are future and contingent expenses they are rarely captured in a small business setting. Whilst they may not ultimately be required, they should always be accounted for.
Taking up a provision for these expenses in your accounts may cause a short-term hit to the profitability of your business, but you will ultimately be far more comfortable and prepared for unexpected liabilities that may arise in the future.
For example, if an employee who has worked for you for 15 years suddenly resigns, have you provided for the significant payout that will be required due to unused long service, annual leave or redundancy?
In a small business setting, the answer is usually no and when it does occur the business may be unable to pay out what they are required to.
5. Keep your personal and business finances completely separate
In a small business setting, all too often there is a blending of personal and business finances. We often see personal credit cards being used in the business and business credit cards being used for personal expenses. The rationale is usually that my company’s money is my money. Do not fall into this trap.
Not only are there a number of potential adverse tax impacts of doing this (for example Fringe Benefits Tax), but it is a very bad business practice. Even if you are the sole shareholder of the business, its funds are not your personal funds and should not be used as such.
Do not pay for your groceries, fill up your car or loan money to your family with business funds – it is not only legally questionable, but this practice makes accounting for these transactions difficult. A true reflection of the business’ financial position is often blurred and the lack of financial discipline will manifest itself negatively throughout the business.
If you require funds for personal reasons, pay yourself a salary or a dividend out of the profits of the business. You can then use these funds to do with as you wish, without the risk of adverse tax liabilities or legal implications.
For any further information or if you would like a review of your business’ cash flow, please contact our office and we will gladly assist.