Business finance covers a lot of ground including accounting, taxation, foreign exchange, business analysis, and business financing to name the main groupings.
And while all these areas fall under the same umbrella, they don’t necessarily work in harmony, especially when some of these activities are outsourced to a third party accounting practice.
For small and medium sized businesses, a common example of this is the impact of annual financial statements and business tax returns on a businesses ability to borrow money.
Many business lenders follow fairly rigid criteria related to financial ratios including balance sheet leverage and payment coverage. These ratios and others can be directly impacted by the decisions business owners and managers make with their accountants with respect to tax strategies.
Most business owners and managers don’t necessarily understand the connection between taxation and financing and in some cases, believe it or not, neither does their accountant. The primary goal is to reduce taxes and therefore improve cash flow.
There is nothing wrong with this approach as long as you don’t require business financing to operate your business. If you do, then here’s a couple of things to be mindful of.
First, if you have a senior financing facility in place with a debt lender, there are likely financial covenants in place that require you to main certain ongoing levels of balance sheet leverage and income profitability that are relative to the amount you’re borrowing. Aggressive tax savings strategies can put you off side of these covenants which at the worst will get your loans called in and at the least will increase your cost of borrowing.
Second, if you try to secure new business financing capital with financial statements that are over leveraged and/or do not show enough debt servicing ability, there’s a very good chance that funding will not be available, or if it is, it will come at a higher cost.
Bottom line, there is a balance between minimizing business taxes and maximizing borrowing capacity. Failure to maintain or keep track of this balance can be very costly in the long run.