Steady as she goes

 

‘Steady’ is not a word you’d normally use to describe an entrepreneur.

The more typical image is as flamboyant buccaneers, identifying a customer need, raising capital and using energy and intellect to fulfil that need, managing risks along the way.

Tales abound of erstwhile entrepreneurs starting an enterprise in their parents’ garage, from a laptop in their bedroom or from a run-down shop. Almost overnight they become millionaires, then billionaires and high-profile media personalities.

That happens, of course, but for many business owners the journey to riches is a little more sedate and in some cases, more predictable. The few who do succeed (the statistics say that the majority don’t) and become successful and wealthy often achieve this over years, or decades of steady and predictable growth. 

Through the wonderful power of compounding (known and loved by many investors), 10% growth, year after year, will create a business of scale if carried on for long enough.

Of course, most businesses don’t grow in a straight line. 

They have good years and bad. 

The year 2020 for many businesses will be more about survival than growth. With depleted reserves and additional loans, many may take several years to recover. But recover they can and as long as the longer term trajectory is up, they can get back on their former growth curve.

Let’s look at an example. 

A small shop with turnover of £100k in their first year. Sales growth averaging 10% each year for 20 years would rise to a turnover of over £670k in year 20. That’s growth of nearly 7 times! That excludes inflation. So that is more units sold, more profit (if margins and overheads are managed) and more scale.

Of course, that is a hypothetical and simplistic scenario. 

There’s a truism in business though - that what you plan for, you achieve. Planning for a minimum of 10% growth (in normal times) is eminently achievable for most businesses. The plan needs to have substance - in our example of the shop, in one year growth may come from increasing the range, another year from expanding or reconfiguring the space, adding new employees, moving on-line etc. Growth won’t be linear but if the trend line is a minimum of 10% growth, scale can be achieved by steady, consistent, application.

Getting rich quick can be a compelling and seductive objective for some. The lucky few with extraordinary talent or perfect timing may succeed.

For the majority, steady, persistent application can deliver similar results...but it doesn’t happen overnight.

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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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Bouncing back with a Bounce Back loan?

The Government’s Coronavirus financial support measures have broadly involved grants and loans.

Grants to support job retention by furloughing employees, grants for business rates support and grants for the self-employed.

Loans in the form of tax deferrals, the Coronavirus Business Interruption Loan Scheme (CBILS) and the recently announced, Bounce Back Loan Scheme (BBLS).

Grants are ‘free money’. They don’t have to be paid back so the decision to take one, if needed, is a ‘no-brainer’. In accounting terms it is treated as income in the profit & loss account and is taxable. It would be good practice to spread the income over several months in the accounts over the period of need, rather than including it all in the month of receipt.

So what about loans?

Again, tax deferrals are  worth doing. They are interest-free and allow you to pay certain taxes at a later date. In these uncertain times, that provides a bit of contingency. The tax deferred should show as a liability on your balance sheet and cash flow plans should reflect the new, later payment date.

Longer term loans like CBILS or the Bounce Back loans require a bit more thought. 

The Bounce Back loans, launching on 4 May are good value. No interest or repayments are due for the first 12 months. After this the interest rates will be relatively low at 2.5%. Banks have promised a simple, on-line application and approval process.

The first instinct of most business owners will be to apply for one. Cash is tight, the future is uncertain and it provides a bit of a buffer. These are good reasons.

Good sense though would be to think ahead and plan how you will use the loan. Ideally this should be within the context of a forecast of profits and cashflows over the next year or two. A key consideration should be that the loan repayments, when they fall due, are affordable.

So grants, yes. Tax deferrals, yes. Loans, maybe, but with some caveats.

Think hard about what you will use the loan funding for, before you apply and try to make it last for your recovery period and beyond.

When its gone, its gone...so plan a few months ahead, beyond your immediate and urgent needs.

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Its all changed, but good business practice still applies

This is an incredibly difficult time for everyone, both personally and professionally. 

I’ve rewritten this blog once or twice as I don’t want to understate or show any lack of empathy with the difficulties some businesses face at the moment.

For business owners, our woes don’t compare with key workers and those on the front line in the NHS, but there are huge challenges nonetheless.

For some businesses, especially those in retail, hospitality and leisure, turnover has dropped almost instantaneously to zero. For other businesses there has been a sharp decline and the future is uncertain. It’s as if all the day to day challenges we all face as business owners have been crammed into the space of a few weeks and magnified several times over.

It’s tough and we are all trying to navigate our way through.

The Government financial support measures will help many businesses through this period. As business advisors we have spent much of the last few weeks advising our clients on what support measures apply to them and how they can make a claim. For some its a lifeline, for others they have slipped through the net, at least for now and are doing what they can to get by.

Despite all the difficulties I want to argue that the basic rules of doing business should still apply. 

That is, it is incumbent on all of us to negotiate in good faith and only agree to receive products and services we can afford to pay for. If we’ve had a sudden financial shock and meeting agreed payment terms is not possible in the short term, we should speak to our suppliers and try to agree a mutually acceptable way forward.

Something which I believe is not particularly helpful or constructive is saying to suppliers, ‘Things are tough, I’m not going to be able to pay you for a while.’ Another way of putting this is, ‘I’ve prioritised things and paying you is not a priority.’

There have been well-publicised instances of some larger firms doing this and leaving their suppliers high and dry. In my own network I am aware that this has happened a number of times.

In some cases, as well as stopping payment, the customer was still expecting to continue to receive services until their situation improved.

Of course I get it that things are tough. Of course I understand that businesses want to hold onto their cash. Survival is their main objective.

But shifting their problems onto their suppliers isn’t helpful in the longer run. 

A sensible compromise is agreeing a reduction in the ongoing scope of services delivered to what is affordable and perhaps agreeing extended payment terms for old debt.

So everything is different but good business practice still applies.

As the Government has said, this will end at some point and more normal trading conditions will resume. 

Following good business practice during this period will ensure we have a better chance of emerging in good shape and with positive business relationships when the time comes.

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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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Getting paid

Most of us are in business because we are doing something we love or are good at.

We didn’t go into business because we are good at negotiating a price for our product or service and then collecting payment when the work is done.

Without sorting out that part of business however, we could end up being busy but poor.

So how do you reduce the risks of not getting paid?

Here are a few steps which could apply to most businesses:

1. Agree a price in advance for your product or service.
2. Agree payment terms and ideally have a formal written agreement which outlines the work you will do, when it is finished and when and how you will be paid.
3. For new customers or start up business ask for some or all of your payment in advance.
4. When the work is done send your invoice in a timely manner.
5. Follow up if the customer doesn’t adhere to the payment terms.
6. Use the small claims court if the customer persistently avoids paying or breaks promises to pay by a specific date.

These steps won’t guarantee you will be paid every time but they will reduce your risk.

Another good tool in your ‘getting paid’ box is , ‘change orders’ or variations to your contract. These are important when you start off doing the work you were asked to do and the customer keeps asking for something else.

Referring them politely back to the scope of work in your agreement is a first step. If they want the new work doing and it is material, this is where your change order comes in to agree new terms for the additional work.

Someone once said that stripped down to the basic processes, business is simple - ‘make, sell, bill, collect’.

The last one can be tricky to manage but if you want to stay in business you need to do it well.

If you are a one person business you will need to do the collecting yourself. For established or growing businesses, having robust processes and resources in place to manage this key activity is essential.

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