by Franchise Accountants
last updated 22/06/2023
Know the Numbers That Count
by Franchise Accountants
last updated 22/06/2023
Philip Morrison offers advice on managing cash flow and paying tax
Over the years, the award-winning team at Franchise Accountants has helped thousands of people from hundreds of different franchise systems to buy, manage and eventually sell their businesses. As business owners, they each have different strengths: some are great at sales, others at building teams, others at seizing opportunities or containing costs. But one thing all business owners need is a basic understanding of financial management.
There’s nothing worse than getting to the end of the financial year, looking at the figures presented by your accountant (and the tax you have to pay) and thinking, ‘There’s no money in my bank account – I can’t possibly have made all that profit! Where did all the money go?’
The assumption is that if the profit made on paper is not reflected in the bank balance, it can’t be true. But profit and cash flow are two different things. Here are some practical insights into key financial matters that affect the cash flows of a business.
Cash v Profit
First, it’s important to understand what profit and cash flow actually mean.
Where does the cash go in a business?
Once you are clear on the difference, you need to look at where your cash is actually going to. Generally, the cash flow a business generates is used to fund four areas of a business:
- Working Capital
- Capital Expenditure
- Owner’s Drawings
- Servicing Debt
Working capital is the cash you need to cover the timing differences between when you pay for the product or services you are reselling, along with the wages used to deliver them, and when you get paid for those products or services. You also need cash to pay for overheads such as rent, insurance, etc.
So while you might make a profit by selling something for more than it cost you, it takes time before that profit materialises into cash in your bank account. The longer it takes, the more working capital you need to cover the gap. This is why a profitable business may be cash flow poor. Read more about working capital at www.franchise.co.nz/article/1872.
The cash the business generates may also need to be used towards capital expenditure, such as buying assets. One business owner came to us in distress at having to put money back into the business to fund taxes and pay suppliers. His business was making a profit, so where had the cash gone? On investigation, he’d taken cash out of the business to buy a new car earlier in the year – cash the business needed. Instead, he had to take out a loan for the car so that the cash flow worked.
Remember, just because the cash is there doesn’t mean you can spend it. It may be already committed to pay your taxes or service your loans.
It’s common practice for business owners to draw money from the business to live on. This is called drawings. The tax on these drawings is paid at specified times throughout the year and the owner is what is called a provisional tax payer.
When taking drawings, business owners must allow for the need of the business to pay its taxes, fund the working capital and service its debts. The most common source of cash flow pressure is when all the cash in a business is sucked out without properly budgeting for these.
Operating a business often requires taking up loans to fund capital expenditure on equipment, vehicles or the franchise itself. Setting the repayment terms to fit the cash flow of the business is critical. Trying to repay loans too fast will drain off much-needed cash; repaying them too slowly will see the assets they funded wear out and need to be replaced before you have finished paying for them.
Consulting a franchise-specialist accountant before you set up your business is hugely important to your chances of success. On an ongoing basis, reports such as the cash summary report or the cash flow reports that your online accounting software produces are excellent tools to help you diagnose where the cash in the business is going.
Death and taxes are things none of us can avoid, so knowing your tax obligations is essential for all franchisees if you want to operate sustainable businesses.
It might sound hard to believe, but paying tax is a good thing – it means you are earning a profit. However, you don’t want to pay more than your fair share, so this is where you can benefit from an accountant’s expertise to minimise your tax spend within the boundaries of the tax laws. We recently prepared a set of accounts for someone who previously did their own tax returns. While ensuring they were compliant with tax requirements, we found more savings than we charged in fees. Good advice pays, not costs!
Operating a long-term sustainable business requires sustainable cash flows to fund it. We recommend that you invest in having budgeting and cash flow reports prepared right from the start, with an explanation of how to read them and update them as reality unfolds.
It’s a worthwhile investment that will help you with your decision-making in operating your business.
This advice is of a general nature only and expert advice should be sought to get the right advice for your specific situation.
For more information and advice on buying a franchise get your FREE copy of Franchise New Zealand magazine.
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