Government moves to lower the costs of compliance for small to medium sized businesses come with a two edged sword. They remove the requirement for an estimated 98 per cent of New Zealand businesses to prepare general purpose financial statements, but they have left many businesses rudderless when navigating the financial oceans.
In a just released white paper, Tim Keenan, Partner and National Director, Privately Held Business at Grant Thornton New Zealand, said the intent of the law change is good, but it has the potential to leave many businesses not knowing exactly where they are financially.
“The naïve business owner only prepares accounts that the law requires. However, the astute operator prepares regular management accounts, cash flow statements and forecasts, which gives them a snapshot of where they are at and lets them plan for the future. Also, other stakeholders such as banks often require regular financial reports,” he said.
Keenan said that financial statements are more than a compliance issue; they’re one of the most critical tools available to ensuring financial performance supports the long-term survival and success of the business.
“The bottom line is that not preparing general purpose financial statements is likely to cost more in the long term than the medium and, short term savings resulting from not preparing them.
“For a small business, there are some perfectly acceptable accounting software packages that can be bought off the shelf or from the cloud. A small investment can pay big dividends in planning and understanding the day-to-day financials of the business,” he said.
The recent media coverage of construction companies getting into financial strife in the Christchurch rebuild market is an indication of a lack of financial understanding and planning among many of these owners, according to Keenan.
“Many of these companies could have averted the financial pressures that they are under by taking some simple steps that would have kept them away from the abyss. And as I have already said, the cost of preparing financial, income and cash flow statements, as well as a balance sheet, are small compared with the damage that can occur when a business gets into trouble and the knock on effect that can hurt owners, staff, customers and subcontractors.”
Keenan said that that there are four simple steps a business could take to ensure they have a clear understanding of their financial position and performance. These include preparing:
A starting point is the regular preparation of financial statements, which is a formal record of the financial activities of a business. These statements allow business owners to:
- see the role cash plays in every business decision
- understand whether the business is running at a proﬁt or a loss
- calculate funds needed now and in the future to ensure short-term positive cash ﬂow and medium to long-term growth.
For lending purposes, financial statements help owners to:
- judge their ability to repay loans
- assess whether lending is justified and, if so, how much and over what term
- decide whether to buy or lease assets, and if buying, whether to seek financing for them
- assess what collateral is available to secure a loan.
The income statement summarises revenue and expenses. The bottom line of the income statement shows net income. Net income, in turn, shows whether the business is profitable or not – right now.
The balance sheet is, literally, a snapshot in time. It lists the assets and liabilities of a business on a given date, comparing what the business owes against what it owns.
Like the income statement, however, the balance sheet is a powerful indicator of business health. As every business owner should know, cash is critical – and the balance sheet allows owners to calculate how many days of working capital they have available, which in turn measures the business’s ability to pay its bills during typical fluctuations in revenue.
Failure to understand this metric can lead even a profitable business to insolvency if it has a period of loss without a sufficient cash cushion. In the worst-case scenario, it can also lead to directors of the business facing litigation, based on demonstrable mismanagement.
As a general rule of thumb, a business should have at least 60 days of working capital. A strong balance sheet (business) will typically have 120 days or more.
Cash flow statement
If you think cash is king for a business, you’re right. And the power behind the throne is the cash flow statement.
This statement shows how much money has come into and gone out of the business over a given period, and how much will be kept on hand to cover emergencies. Keeping the statement current and valid forces the business to make sound predictions about future sales and purchases – and, as far as possible, meet or exceed the former while staying within the latter.
“Too often a business owner has no problem buying the latest ute or “toy” but will baulk at any form of investment in financial/accounting advice. That’s unfortunate, because a relatively small investment in regular financial advice could mean that they ensure their business is profitable and sustainable so they can keep their utes and toys in the future,” he said.