Being that we are now in the first week of December, many business owners with December 31st year ends will be or should be projecting what their financial statements will look by the end of the month in order to have the opportunity to improve the final results in the coming weeks.
Traditionally, a year end planning process is for taxation, and taxation purposes only. While tax planning is definitely something that should be seriously looked at this time of year if you have a December year end, there is another aspect of business finance that is mostly overlooked in the process by both business owners and their accountants.
The year end financial statement that typically gets prepared up to 6 months past the end of the actual year end, is a very important and arguably the most important element of a business financing package for an existing business.
Sometimes in the pursuit of reducing income taxes at any cost, business owners create other problems for themselves in the areas of securing capital or maintaining the capital they now have access to.
For an oversimplified example, business financing problems can be created by income statements that show no or low profitability and balance sheets that show no or low retained earnings.
In many cases, year end tax planning activities will occur to either spend more on future needs to reduce the net tax position at year end or move profits out of the company to optimize both the business and personal income tax positions of the owner(s).
While these types of actions may very well result in considerable taxation savings, they also end up painting a less than flattering financial picture for the business for the period just completed.
Logically, one could argue that lender or investor would be able to understand these actions and take them into consideration when reviewing the financial statements. Unfortunately, logic doesn’t have much to do with it. The financial statements are in almost all cases related to business financing, taken at face value.
As a result, two potentially negative outcomes can occur.
First, for the business that currently has business financing facilities in place that require specific financial covenants to be upheld, the year end tax planning activities can potentially cause a business not to meet some of the covenants which could result in the lender calling in the loans or taking some type of corrective action.
Second, for a business trying to secure incremental capital, the year end financial statements may not show the ability to repay the debt or show a debt to equity position that can support a greater level of borrowing.
Both of the above scenarios can be disastrous to a business, where at the least significant opportunity is forgone, or at the worst, the business cannot cash flow its operations and ends up closing down or going bankrupt.
To avoid both scenarios, the year end planning process, either for a December 31st year end, or for any other year end date, needs to take into account how the final version of the financial statements will impact all business finance aspects of the business (taxation, cash flow management, ability to secure capital, and so on)
To some degree, taxation can actually be looked at as a financing cost, as failure to pay taxes or have taxable earnings, may limit or restrict the business from acquiring and maintaining business capital, especially lower cost debt instruments.