When the dividends don’t work

Most owner/directors of private limited companies will choose to pay themselves with a mix of salary and dividends.

Usually the most optimal set up is to pay themselves a salary up to the National Insurance Primary Threshold and top up the rest of their income as dividend.

In the current tax year (1920/21) that would mean drawing an annual salary of £9,500. Drawing a dividend of £40,500 in addition to the salary would give a gross income of £50,000. The income tax due on this would be only £2,287. No employee National Insurance would be due but a salary at this level would count as a qualifying year towards State Pension eligibility.

In comparison, personal income tax and employee National Insurance contributions on a £50,000 salary would be £12,358. Some £10,000 higher than the combined salary/dividend option.

The tax saving is much reduced if the combined company and personal tax impact are considered. Dividends are paid after corporation tax (unlike salaries they are not a tax deductible expense) so every £100 of dividend paid instead of salary incurs an extra £19 corporation tax. The company would also pay employers' National Insurance on salary above £8,632 per annum.

Nevertheless, for modest incomes, if looking purely on the basis of tax efficiency the combined salary/dividend option works best and most accountants will recommend this route.

So why wouldn’t an owner/director always choose this option?

There are a some cases where I think the salary/dividend route may not be the best choice:

    1. Where there are a number of senior managers who may not be shareholders

Where there are a number of senior managers who are not shareholders there might be a case for the owner drawing a ‘market rate’ salary for the contribution they make and topping up with dividends if profits are sufficient to allow this. This enables the owner to be transparent about profitability and remuneration with their senior management team. They might also combine this approach with a profit-based bonus scheme. The benefits may outweigh the tax savings gained from the salary/dividend remuneration method.

    2. Where an owner is preparing for exit

As above a ‘market rate’ salary reflecting the owner’s true contribution to the business might be a sensible transition in the years before they exit the business. The remuneration can be easily flexed if they gradually reduce their involvement. As with 1 above a top up dividend can be drawn on top of the salary if profits allow. This can be an added incentive for a business owner to drive the business to generate ‘surplus’ profits after allowing for their management contribution. In this way the business may be more likely to become a standalone investment rather than a lifestyle business.

    3. Where there are several shareholders with varying levels of input

Using salary rather than dividend in this case allows greater flexibility. As with 1 and 2 above dividends can be used as a ‘top up’ on the salary where all the shareholders benefit in proportion to their respective shareholdings.

There’s a saying in tax circles, ‘Don’t let the tax tail, wag the business dog’. 

I think it can apply here. 

It's not conventional wisdom for an accountant to say this but, in some cases, less tangible, business and operational considerations may sometimes override harder tax savings.

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Preparing for the new normal

We’ve been in lockdown now for almost a month.

Although the Government have tried to dampen down talk of exit plans, attention is moving to how measures might be relaxed in due course and how we might return to more normal conditions, or perhaps a ‘new normal’. 

The consensus seems to be that at least in the short term, social distancing measures will still apply until a vaccine or another scientific solution minimises the risk of the virus growth accelerating again. 

The most likely sequence for an emergence from lockdown, according to Buzzfeed, seems to be allowing some non-essential shops and industries to open, followed by a relaxation in some social distancing measures and in due course, re-opening pubs and restaurants. Permitting larger public gatherings and events and opening up travel are likely to be further down the track. 

This sequence is still speculative but it does align with measures to relax lockdown seen in some other European countries and the Buzzfeed article has been picked up and reported on by mainstream media.

There is still great uncertainty over the timing and it makes planning difficult for businesses.

But plan we must.

The focus for some businesses has been surviving lockdown. Gaining access to the Government financial support, speaking to their banks, customers and suppliers. This remains the focus for many with essential funding not yet in place to ensure their survival over the next few weeks.

Before too long the focus needs to shift to emerging from lockdown. 

What will this look like in your sector? Some sectors will be permanently changed. Some will have a very gradual return to more normal conditions. There are scenarios we need to plan for and adapt our businesses to the new reality.

One of the buzzwords at the moment is ‘pivot’. In other words, changing your business offering and business model to suit the new conditions. Pubs and restaurants doing takeaway and delivery services, events companies moving on-line, football teams playing in empty stadiums.

Pivoting is a technique widely used in start up businesses. 

If their initial start up offering is not taking off the entrepreneurs will pivot their offering to make it more attractive and relevant to customers. Often these pivots are very radical and involve a complete rethink of the business, starting with the customer and how the assets and resources of the company can best be deployed to meet their needs. 

One of the most unusual and counter-intuitive pivots I read about recently was a former events company which is now manufacturing and distributing its own brand of gin.

Most of us will not be doing anything as radical as moving into the gin business but we may need to think about making some significant changes to adapt to the new environment. 

Will our sector return to a ‘pre-Covid’ situation when we come out the other side or will it be permanently changed? 

We need to be ready and prepared for the ‘new normal’ when it comes.

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Is your business an investment or a lifestyle?

Business owners tend not to think of their business as an investment. 

More often than not they’re a ‘hands on’ owner, usually working hard in the business they founded, managing the team and driving the business forward.

An investment?

Not really. Sure, they may be a shareholder and take dividends on top of their salary but typically the business is their meal ticket. They run it as well as they can, they draw an income (maybe not quite as much as they’d like) and often there’s not much of a surplus after that.

So really it’s a lifestyle business.

They enjoy it (most of the time) and it pays the bills but is it a saleable asset? To have value the business needs to make a profit after allowing for replacing the owner’s drawings with a ‘market rate’ salary. In other words if a competent manager was hired to replace the owner, what profit would the business make? If the answer is nothing or a very small figure, the business does not have a great deal of value.

All is not lost though.

Lifestyle businesses can transform themselves into a business that is a genuine investment. A business that is resilient and sustainable and generates a profit without the day to day input of the owner.

It requires robust processes and systems and a strong and capable management team. It won’t happen overnight. It needs a plan and consistent effort.

A profitable business not reliant on the owner becomes a business worth keeping or perhaps selling to a buyer who can see a healthy return on their investment.

So thinking of your business as an investment can be a good thing. Transforming it into one is even better.

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Feast and famine

Accountants are lucky.

Lucky in the sense that a lot of the work we do is ongoing or repeat business. So if we look after our clients and do the right things, our firms should grow in an incremental way as we add new clients.

In other sectors things are less straightforward. A contractor on a 6 month contract needs to find a new customer when the contract ends. The same goes for a builder when they finish the extension they are working on or the freelance designer putting finishing touches to a new company logo.

When the current job stops for these guys, there can be a gap until the next one starts. That’s not a nice place to be. Bills still need to be paid, life needs to go on, but money may be tight.

So what’s the solution? How can the feast and famine cycle be avoided?

It’s a particular challenge for start ups who may not have the profile or recognition to generate a steady flow of new enquiries. 

Let’s start with what won’t work. 

Just waiting passively for the next customer, the next job to arrive, won’t work. 

You need to make your own luck. That means in the fallow periods putting all your energy and focus into finding the next customer. Whatever it takes. Following up old contacts. Networking. Finding your social media channel and using it to engage with potential customers. Email. Direct mail. Cold calling. Measure the results and keep doing what works.

Then you get lucky. You get a good lead. Proposal leads to an order and you are on the way again.

It feels great. This what you love. You get stuck in. 

This time though, you need to try and break the cycle and get your next job lined up before you finish the new one. That means putting some of your time aside every week for marketing (attracting new leads) and selling (doing your pitch and closing the deal). I’d suggest that about 10 to 20% of your time is about right for this so that’s half to one day a week. It could be one set day every week or an hour or so a day. It just needs to get done.

The feast and famine cycle is not a good way to run a business. It needs discipline and focus to break it and have a more regular flow of work.

The ideal is that you choose when to be idle rather than having it imposed upon you. 

When you are on holiday after a good spell of continuous work and your next job or jobs are lined up for when you get back, you will know you are on the right track.

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Partnerships should come with a health warning

Partnerships can be a beautiful thing.

Two people (it is usually two) working together to achieve more than they could on their own. 

It sounds great but the reality can be different. I’ve failed at working in a partnership. My ex-partner was (and is) a lovely, capable guy but being a double act didn’t work for either of us. We went our separate ways in business after a couple of years and I think we have both been happier and more fulfilled since the split.

Thankfully our break-up was fairly harmonious (they are never completely so) but in my time running an accountancy firm I have seen some less-friendly splits where the partners have ended up falling out very badly indeed. Often the rift comes from an imbalance in the relationship. One partner feels they are working harder or want more from the business than the other. Tensions build and often come to a head with an agreement to break the partnership.

For me it was a learning experience. On the positive side, having a partner gave me the confidence to start and develop the business. After we achieved a modest amount of scale however, I wanted more control of decision-making and mapping out the future direction of the business. In a nutshell I wanted to be master of my own destiny. 

I have seen some partnerships that work. More often than not, these are a couple who are already in a relationship. They are used to dealing with the ups and downs of life - falling out, making up and able to communicate effectively with each other.

One of the key ingredients in successful partnerships I believe is having clarity of roles and responsibilities. At the start up stage, each partner tends to ‘muck in’ and do what needs to be done. Very quickly they will need to carve out roles built around their individual strengths. One partner will usually emerge as the leader and I think it works best if each partner is responsible for different activities - marketing, selling, operations and so on.

Another important feature of successful partnerships is communication. More than this it needs to be open and honest communication. I have observed partnerships where there are clear roles and responsibilities, one partner is clearly the leader and the partners get on well. The weakness has been that the junior partner has not been able to communicate their concerns effectively to the senior partner. This has led to the senior partners taking excessive risks with poor outcomes for the business.

Partnerships can work but if you are thinking of joining forces with a work colleague or friend, my advice would be to think hard and then think some more. Visualise how you will work together, not just in the good times but in the bad times too, which will inevitably arise. 

Before committing, spend some time together preparing a business plan. This can ensure that you are 'on the same page' at the start and is a good trial for seeing how you work together and reach consensus,

1 + 1 can equal much more than 2 in the best of partnerships.

In some cases it can be much less than a sum of the parts and can lead to the end of a close and long-standing friendship. 

So tread very carefully and do your homework before taking the plunge. It may help you avoid an expensive and often painful mistake.

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Failing is overrated

We see articles all the time saying how great failure is. 

It’s an opportunity to learn the lessons, dust yourself off and do it differently next time. 

Great thinkers and great inventors like Einstein, Edison and Archimedes are quoted. Failing hundreds or thousands of times and then...Eureka! 

Success at last. 

Learning from failure and being resilient enough to try again are of course important and can be a path to future success. This is particularly true when blazing a trail in a new field like inventing stuff or astro physics. There is no roadmap to follow so experimentation is the only way.

On a personal level, learning from failure and trying again is a positive thing. We try some public speaking which doesn’t go as well as hoped, or try a particular approach with a customer or employee which falls flat. Stopping, reflecting, learning and trying something different next time makes perfect sense.

Ok, so I agree that learning from failure has its merits. 

That’s all good but a better and smarter way way in most cases is learning from success. What sets humans apart is access to knowledge and best practice. Observing and learning from successful people, successful teams, successful leaders and so on is a quicker and less painful route in most cases than learning from failure.

So in business we can start up a new venture and plough our own furrow, making mistakes as we go, tweaking, adapting and moving on after each setback. Or we can learn from the best - the Jobs', Bransons, Krocs and Disneys of this world. Or maybe that guy you met at a networking group who started his business at a similar time to you and seems to be doing brilliantly well. What did they do that led to their success? Can you take the best of what they did and sprinkle it around your business?

We can also learn from success by surrounding ourselves with experts and mentors who have knowledge and experience they can share to help us get things right, the first time we do it.

So by all means let's learn from our failures but let's also be hungry to learn from success.

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What business are you in?

A deceptively simple question. 

It was first posited by management guru Peter Drucker who argued it is a fundamental thing which all businesses should ask themselves and consider carefully before deciding on the answer.

An accountancy firm ‘does’ accounts and tax, a restaurant serves food and drinks - simple?

Well...maybe not. 

How that question is answered can shape the culture, behaviours, investment strategy and development of a firm. 

If an accounting firm does accounts and tax -  do they also provide advisory services? 

A restaurant provides food and drinks - to what kind of customer? What kind of customer experience do they create?

Let’s look at some examples. Blockbuster probably thought they were in the video rental business, at least that’s where they stayed. If they had been in the ‘home entertainment’ business might they have diversified or been more alert to the advent of streaming and pay per view channels? Maybe if their definition of the business they were in had not been so narrow we’d be selecting our Friday night TV viewing from a Blockbuster channel alongside Netflix and Amazon?

The classic example of a firm who have an innovative and broader view of the business they are in is Disney. They made the leap from Mickey Mouse shorts to big screen movies to TV to theme parks by being in the business of ‘show business'. To quote the great man, “I never called my work an ‘art’. It’s part of show business, the business of building entertainment.”

We may not all be as visionary as Disney but small business owners should think hard about this question. 

An accountancy firm may well ‘do accountancy’ but they may have a market niche (like dentists or consultants etc) or maybe they are in the business of helping their business customers achieve their goals? 

Many businesses bumble along quite happily without having absolute clarity about what business they are in or maybe having too narrow a focus. Blockbuster survived quite nicely for quite a few years. 

I go back to my opening line. It’s a deceptively simple question.

The answer doesn't have to be obvious. It can give your business a unique identity and purpose.

It may end up defining its future direction and longevity.

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What's on your 'To do' list?

For a typical business owner it will be a wide range of things.

From the strategic to the tactical. From the long term to the shorter term and the downright urgent!

It strikes me that the contents of your 'To do' list can tell you a lot about how you are managing the business.

If the items on your 'To do' list are leaning more towards the tactical/short term/urgent, you are probably still at the 'Technician' phase of managing your business described by business guru Michael Gerber. You are still very hands on 'doing' and delivering the product or service to your customers. Strategy? Whats that? I haven't got time to breathe never mind think about being strategic!

If your 'To do' list content is more long term/strategic - recruiting a new senior employee, negotiating terms with a prospective new customer, looking at a new IT system to improve effectiveness etc you are probably in the Manager/Entrepreneur phase. You are thinking in the longer term and perhaps engineering how your business can continue without your day to day input. That is a much better place to be for a business owner.

Well that's all well and good but an urgent list is an urgent list and this stuff needs to get done! 

That is true. When I get into overwhelm mode - it happens to us all from time to time, I review the list and set priorities. Is there anything on the list that can be delegated or deferred? With some tinkering, planning and thought the list can be made more manageable.

That sorts things out for the immediate future but what about the longer term? 

If 'overwhelm mode' is the normal state of affairs for a business owner, some time needs to spent on thinking how things might be made more manageable over time. That might need some time out from the business to think things through and work out a plan. An external facilitator can help here to help you look at things afresh and bring new ideas.

So do think about this if you feel trapped by your jobs list. We all need plans and 'To do' lists. They are what move us forward. For business owners, your list should be motivational and moving you towards a longer term goal.

If that's not the case with your list, it's time for action.

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Letting go

Every business owner wants to be set free from their business.

At least they should want this. A business which can run effectively without day to day input from the owner is much more valuable than a business which is reliant on him or her.

Value aside it must be much more rewarding in a practical sense having a business which works for you rather than just being being your place of work. 

That’s the theory. The practice is much more difficult.

If being ‘the boss’ has been your raison d’etre for 10 or 15 years, to morph into someone who is not needed and maybe even gets in the way a bit, is a difficult transition.

Part of the DNA and make up of business owners and entrepreneurs is being driven and busy. Long ‘to do’ lists, not enough time. Demanding customers, challenging suppliers,  employee problems. Stress. Adrenaline.

When you stop being essential to the business its hard to let go of old habits of jumping in, fixing problems and doing things the way you’ve always done them.

So what’s the solution?

Well I’m no expert because I am still fairly hands on with my business. My employees would be the judges of how needed I am. Maybe I’ll ask them. 

But getting back to the solution, I think the first thing is to learn to let go of the guilt. It’s ok not to be busy. It’s your business. You’ve put in the hard work. You’ve built the team. Now let them get on with it.

You can of course put your energy into something else - a new hobby, a new business venture or developing a new stream of your existing business.

If you have managed to find your freedom be sure to celebrate it. It’s a nirvana that many business owners never reach.

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Something for a rainy day

To put something aside for potentially difficult times ahead is not a new idea. It’s something most of us do to varying degrees. 

For personal finance, Financial Advisors recommend that its good practice to have an emergency fund of readily available cash to help deal with unforeseen events - a new boiler, new tyres for the car etc. An ‘ideal’ emergency pot might be about 3 months salary - enough to keep you going for a while if the worst happens. For the most organised amongst us, the emergency fund would be in addition to other longer term savings plans.

So what about the event looming on the horizon for those of us living in the UK which is not too far away - a possible no deal Brexit on 31 October? I read recently that some observers are now saying the likelihood of a no deal Brexit is greater than 1 in 3. The direction of travel seems to be changing from ‘no deal’ being a ‘possible’ outcome to a ‘probable’ outcome. The turbulence with the exchange rate and the stock market in recent days suggests the markets believe there is a strong possibility of rocky times ahead.

So what can small businesses do to prepare? There are specific, technical planning measures that businesses who import and export will need to take. For businesses that employ EU citizens working in the UK there may be changes they need to make to ensure they are compliant. There will be some changes to VAT rules, especially for exporters. These are all things that need to be looked into carefully and plans made. 

But what of more general plans? Is ‘Keep calm and carry on’ enough?

I think, probably not. I think the key thing for all businesses is to be prepared for some kind of downturn. If it’s not as bad as Boris’s, ‘Doomsters and gloomsters’ predict, that’s great. All that’s been lost is a bit of time planning and preparing.

Modelling different scenarios is worthwhile. If your sales fell by 5% or 10% for 6 months what would you do? Do you have enough reserves in the business to carry you over a hump or do you need some extra funding? Increasing your overdraft limit now, before you need it is better than asking when business finance becomes more critical. Can you cut back on some of your major costs quickly if you need to? Can you reduce your drawings from the business to steady the ship?

None of us know for certain what will happen in the next 90 days or so. A bit of advance planning will ensure we are at least prepared. So think about getting your whiteboard out next week and looking at your numbers.

If the rain does come down at least you will have your brolly with you

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Burgers and bookkeeping

Most businesses are in control of how they provide products or services to their customers.

A McDonald’s burger is a McDonald’s burger. It’s done the same way, every time. When you get a flight you turn up at the airport, do check in, go through security and passport control, sit in your selected seat and follow the process. In a restaurant you are greeted, shown to your table, choose your food, it arrives, you eat, you leave.

McDonald’s is the extreme example of a business owning and controlling the process but most businesses do the same, to some degree.

Except, perhaps accountants. All our clients are different it seems. Some provide their records to us in a carrier bag, some in shiny folders in monthly batches, some via email or Dropbox, some summarised on Excel spreadsheets, some on accounting software. Some tidy and reconciled, many not.

So often we work in different ways and using a different process for different clients. That’s a challenge because we need to adapt to each client and have a good working knowledge of multiple accounting systems. ‘That’s what our clients want’, many accountants would say. Maybe, but it’s not terribly efficient and maybe our clients ‘Don’t know what they don’t know’

I’m happy to admit that we have followed what we believed to be the ‘client friendly’ method. However the records are presented, we will find a way of coping with it.

I believe now that things have moved on and we are not acting in the client’s interest if we do not direct the process more than we have in the past. If we can scan receipts, quickly and easily why would we not encourage our clients to do this to save time and simplify the process? If we can use software which downloads the bank feed and automatically matches invoices to payments and receipts, why wouldn’t we take advantage of that? And why would we not use intuitive dashboards rather than paper-based or pdf reports?

Some firms have taken this on board such that they work with a single accounting package with associated apps and they own and control the accounting process with their clients, including doing the bookkeeping in most cases. They get huge efficiencies and economies of scale which they can pass onto clients in terms of improved services and ‘value-adding’ advisory support.

We may not go quite to the extent of prescribing a single accounting system but I do believe standardising how we receive records from our clients and our own internal processes is beneficial for us and our clients.

Accountancy may be different from burgers in a bun but we can learn a lot about consistency, value and service from Ray Kroc and his empire.

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Riding the wave of the latest killer apps

I started my career in accounting just when the the last big ‘killer app’ arrived. 

The spreadsheet. 

We can’t live without them now and Excel has become the ubiquitous market leader as part of the Microsoft Office suite. 

Before the spreadsheet arrived ‘number crunching’ was a big part of accountants’ lives. Checking column and row totals in their clients’ manual records. Cross-casting on their own large analysis sheets. Lots of time spent checking and adding up lots of numbers. This time spent added no value at all to their clients but was a necessary part of work to ensure accuracy.

The spreadsheet changed all that and perhaps more importantly it allowed for rapid analysis and ‘what if?’ modelling. As a management accountant this was my bread and butter. Spreadsheets enabled me to prepare budgets, forecasts, investment appraisals and complete ad hoc analysis, rapidly and accurately.

It’s a tool we still use and can’t do without. It changed the way accountants work and enabled them to provide more value, rather than removing the need for accountants altogether. Undoubtedly some clerical jobs were lost but accountants continued to thrive.

There are new killer apps now transforming the accounting sector in the form of scanning software and cloud accounting software with links to  banking transactions.. 

Accountants ignore these at their peril. 

They have changed and are changing the landscape in 3 major ways:

• Removing the need to key in invoices and receipts into an accounting package
• Increasing the speed with which accounts can be processed and made available
• Access anywhere, any time

These are transformative changes on the scale of those we saw with the spreadsheet. As with the spreadsheet I don’t think these changes will bring about the demise of accountants. They will however limit the careers and prosperity of accountants and accountancy firms who do not embrace the change and adapt to new ways of working.

There is an opportunity to deliver greater value to clients through more timely reporting and analysis and providing more proactive advice and support..

There is a huge benefit for clients and accountants alike if we ride the wave together with these latest killer apps.

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Ch-Ch-Ch-Ch-Changes

‘Turn and face the strange’, as Bowie said.

I’ve lived through and played a small bit part in some big change programmes in my former life as a management accountant at a large food retailer.

Big consultancy firms were involved, large PowerPoint presentations, lots of jargon and buzzwords and backing from the Board. Some went better than others. Key aspects were engaging those affected and ultimately the whole business on why the changes were needed and communicating, communicating, communicating.

Some of the changes implemented like effective meetings, project management tools and process improvement became part of the DNA of the company and helped it stay ahead of the competition for a sustained period of time.

What about managing change in a smaller company - say with 10, 20 or 50 employees? Processes and ways of working tend to be more informal and centred around people and their likes and dislikes rather than a company style. Budgets are small and people (including the owner) are normally working at capacity so there is little time to consider and actively engage with change.

But sometimes change needs to happen.

Small businesses evolve and from time to time they reach a plateau. Perhaps they have become too dependant on the owner. Perhaps the owner is nearing retirement age and wants to move away from doing 50/60 hours weeks. Perhaps the business has become a bit stale and is not focussing on their customers.

Making a change can be difficult but it can transform a business if the owner and key employees commit to the change and focus intently on delivering it.

The same principles of communication and engagement are critical as with a larger organisation.

I strongly believe that an external facilitator of some kind is important if not essential. This could be the company’s external accountants or a business consultant of some description. Their key attributes should be that they are experienced in managing change and ideally with specific experience in the areas you are looking to transform.

Another essential component in my view is to have a programme manager or project manager whose responsibility is to oversee and facilitate the change. This would probably involve freeing up one of the team from their day job for a period of time to manage the change programme.

So you have a plan and the objectives you want to achieve. It’s worth bearing in mind Mike Tyson’s quote, ‘Everyone has a plan until they get a smack in the mouth’. You will probably get several smacks in the mouth to veer you off plan and will need to keep the objectives in mind and try to steer back on track.

With luck, effort and resilience the plan can be achieved and the business taken to a much better place.

Good luck if you decide to embark on your own change journey.

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