Business Financing Tradeoff – Lower Taxes Versus More Borrowing Power

I’ve written a fair bit lately about the importance of financial statements and their importance to business financing activities, especially after the year end.

One of the biggest challenges with getting the most financing power out of your financial statements is to have a tax planning strategy that is in line with your business financing strategy.

Too often, accountants will go through tax planning strategies in a bit of a vacuum, not having any knowledge or appreciation of what the business will require for capital or what if any refinancing will need to take place in the year ahead.  Even if there isn’t an immediate capital need that’s planned, there still is the consideration of things that could unfold and allowing for their potential capital requirements.

And when financial statements are optimized for tax purposes only, they can reduce and potentially destroy your ability to borrow incremental capital in the process.

Effective tax strategies can lower net income which is required for debt servicing and lower retained earnings, which will reduce the amount of equity on the balance sheet available for financial leverage.

What confounds the whole process even further is that each lender will have their own series of add backs and adjustments to income and cash flow that may or may not be impacted by certain tax strategies.

In reality, paying taxes can be viewed as a cost of borrowing in that if the business is not in a taxable position, it won’t have the financial results necessary to acquire and service debt.

So how do you optimize the financial statements for both taxation and financing at the same time?  This is a bit of a difficult question to answer due to all the unknown variables involved on the business financing side.

One approach to consider when the business is actively seeking capital prior to the completion of the year end financial statements is for the accountants to prepare a draft version based on the collective best guess work of the business owner and their third party accountant as to what level of earnings would be acceptable to the target lender or investor.

The draft version can be put forth with the financing application and if an approval can be secured based on these numbers, the statements can be finalized as written.  If financing can’t be obtained for the sought after terms and condition, the draft financials can be further adjusted to optimize the tax position of the business if appropriate and finalized via a revision.

There are other approaches to consider.  Just keep in mind that in order to get the best result for both taxation and capital procurement potential, the business owner and manager need to make sure that they provide their taxation expert with their forward looking plans and capital requirements so that some effort can be made to allow for both requirements if necessary.

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About the Author Brent Finlay