Why tax minimisation might be killing your growth plans

While the tax cost of operating a business in New Zealand is an important consideration to ensure tax efficiency, if you intend to build a business of scale, there is much more to consider than just minimising tax.

We have experienced an increasing number of new clients where the previous focus has only been on tax minimisation. Some of this has reached the point where the decisions have overridden tax deduction restrictions.

This can be shortsighted when growing a business, especially given that growth requires cash, which often requires funding (at least of working capital). When this growth is slower and sustained, it can be achieved by ensuring favourable terms of trade.

However, often working capital facilities are sought to fund growth, which requires financial statements to be provided to banks. Banks look at the consistency of margins, profitability, forecasts and balance sheet position. If you’ve been aggressively minimising tax, this creates problems when you need to present your business to banks. Your forecasts will try to show strong future performance, but your historical accounts tell a completely different story of minimal profits. You might even need to restate your past financials to show what your business actually earned.

Growth needs cash, and banks need stories

All assets, especially those that retain their value, bolster balance sheets. This is even more important to recognise for internally developed assets. We recently saw a case where a business had incurred significant wage costs to develop an asset that is now operational and used to generate income for a different business service. But the previous accountants had written off all those labour costs as expenses instead of treating them as an asset on the balance sheet. The asset values in the balance sheet were understated by at least 50%. This distorts and understates margins, profits and the balance sheet, which are the key items that are reviewed by capital providers, including banks.

Tax payments can become a cash flow burden when business profits exist on paper but haven’t yet translated into liquid funds. Good management of terms of trade and collection will help; however, during periods of growth, this is more difficult as cash is locked up in trade or used to invest in assets. This is when bank working capital funding products can help, and where the financials and forecasts (and the story supporting them), become more than just a compliance requirement.

What works when you need funding

So, how do you find this balance between tax efficiency and satisfying the banks for growth (or any) funding?

• Be clear with your business goals from day one, whether you are building a business or buying one. Are you looking to sustain current performance? Are you looking for growth?
• Communicate your goals to your accountant. If you are looking to grow, find an accountant who can support you with that growth. This should mean more than one meeting a year, at least quarterly or two-monthly. They should be able to help you understand the financial information and have a simple set of KPIs or critical numbers that are monitored month-to-month, that address any issues proactively.
• Ensure your business structure is tax-efficient and aligned with your goals.
• Armed with the above, a good accountant will ensure the business structure is aligned, work within the tax rules to obtain tax efficiency, advise you of alternative tax treatment when appropriate, and the repercussions of decisions based on your goals.
• Forecasts are the key to growth! Three-year forecasts with a closer focus on the first year are ideal. If you don’t have any markers, how do you know you are achieving them? This should also indicate when the cash holes (and requirements) are likely to occur, allowing you to prepare.
• Ensure discipline with any cash drawings from the business. A history of maintenance of cash in the business, which has funded/will fund working capital, is ideal. Not only as a signal to banks, but for the business generally.
• There are tax funding options available for your business, which offer a range of options with reasonable rates.

When you are looking to scale a business, that should be your focus and your accountant’s. Disproportionate attention to tax minimisation will become an obstacle to growth funding. If you are looking to grow your business, ensure your accountant is aware and ask them for their help. If they are not equipped to do so, find another advisor who can help you navigate this journey effectively.