It is instinctive for many business owners to look to minimise their tax liabilities and one way to do that is to minimise their annual profit by legitimate means such as bringing forward expenses, write offs and the like. One of the accountant’s main functions is to provide advice on these matters.
This article briefly discusses profit from another perspective and suggests that a balanced approach is necessary to ensure businesses can optimise their access to finance on the best terms possible.
Banks generally use the average profit of the past 2 years’ financial statements to determine a business’s debt servicing capacity. This profit is adjusted to include addback of expenses such as depreciation, interest and owners’ wages, etc.
To maximise borrowing capacity, therefore, profit should be as high as legitimately possible.
The trade off is obvious – higher profit equals higher tax liabilities but it also improves access to finance and reduces loan pricing in some cases.
There is no right or wrong answer on how to approach this. In my experience it depends upon the business’s borrowing requirements (present and future), the owner’s preferences and accountant advice.
The key is for all parties (client, accountant/adviser and banker) to have a good level of communication so these banking issues can be incorporated into tax planning. Bankers are not qualified to give tax advice, but can provide feedback on impact on loan facilities and borrowing capacity from proposed tax planning measures. If in doubt, get that feedback informally during the tax planning period.
When tax returns are finalised, ensure a full set is provided to the banker. If appropriate also provide an explanation of the adjustments made so they can identify all of the addbacks (an example might be some once-off repairs & maintenance that have been expensed). This ensures the business’s risk profile can be presented as strongly as possible in applications and /or annual reviews.
Good bankers understand tax planning.
The issue of retained profit is a separate but related issue. The amount re-invested in the business improves equity levels and reduces risk. The ratio of debt/equity in a business improves a business’s capacity to withstand shocks and can also have an impact on loan decision and pricing.
Kindly contributed by Laurie Clark – Owner Manager – Bank of Queensland, Maroochydore