The Professional Panel.

An interview between Robert Bradley and Paul Brindley – April 2011.

Robert: How do you see businesses fairing this year? Paul: We have some interesting times ahead, it’s certainly not all doom and gloom. Some businesses will see more, bigger and better opportunities than there have been for a good number of years, as competitors go bust, customers make decisions they have put off for a while, new products and services are developed. Growing businesses face their own challenges – it’s all too easy to focus on growing the top line, getting the production out but forget about the cash. After all, you did not set up in business to manage the cash, you set up to do what you do, because it’s what you enjoy and are good at. Yet cash is the oil in the engine of your business. And any engine without enough oil will fail, regardless of how well the rest of the machine is put together.

Robert: Yes I agree and how should businesses manage growth? Paul: As business grows, the owners role within the business should change. They must learn new skills, look at issues from more than one viewpoint. If they are the ‘technician’ behind the business – the person with the know-how – they need to learn the ‘entrepreneurial’ and ‘managerial’ skills that become ever more crucial as the business grows, take on more people and move into different markets. It is also important that they should never stop learning, and keep asking themselves whether they have got the right balance between the three roles of technician, manager and entrepreneur. Whenever they look at any issue in the business, including its cash flows, they should try to look at it as if wearing each hat in succession. Most of their competitors will not do this, and that is why they should: it’s what will make them different, their growth sustainable and their business stronger.

Robert: What are the strategies needed to achieve good cash flow? Paul: Business owners should take a real, and deep, interest in cash flows, both on a strategic level and daily basis. While cash flow management is an area that they may be able to delegate, they should not confuse effective delegation with abdication of responsibility. Cash flow management shouldn’t just be delegated to the accounts department and forgotten ; they should be challenged all the time and the business owner should fully understand the starting position; know what to expect going forward and what is happening and what their options are each and every day of the week. In other words they should approach this on the basis that they, and no one else, are ultimately responsible for managing the cash flows of the business, including the initial planning, the ongoing control and the driving of the implementation stages!

Robert: Yes I agree but what else can they do? Paul: They should identify where the potential weaknesses in your cash flows lie. Typically for growing businesses these are in late debtor receipts, bad debts, excessive reliance on too few customers, or overstretching their production capabilities. Business owners should try to reduce your risk of their business ‘overtrading’ in the areas they identify. For example, will their customers supply them with free issue material? What will they do if the finance market further contracts and they cannot find the cash to buy that much needed piece of equipment? Can they buy in production capacity as and when needed without compromising quality or profits? They should ask themselves what else they should be doing do to bring more certainty to their cash flows, and then do it.

Robert: and what about planning? Paul: In my experience too many businesses trust to luck and fail to plan ahead in the short, medium and long term. They should stress test their cash flow statements and understand what happens to their cash flows at different turnover levels, they will be surprised at how much these can differ. And have plans B, C and D, which can be put in place quickly, should (or should I say ‘when’) things do not turn out quite as you would expect. Business owners should accept that just because they know that their actual cash flows will not work out as you set out in the early cash flows this does not make their planning a worthless exercise – they will learn a lot about the mechanics of their own business from producing and understanding the cash flow statement. And as they go along, continually update the business cash flow statement. It shouldn’t just put it in a drawer and forgotten. It must be retained and used as a key tool for managing the business.

Robert: Do growing businesses need more cash? Paul: Yes..all businesses that grow need more cash, even if the cash flows don’t show it! Understand, I mean really understand, what the key drivers are for that increased need and plan ahead, identifying and assessing all the options for satisfying those needs. Funding options should be discussed with experts in the field. Business owners shouldn’t try to go it alone, they will not identify or know how to access or recognise the advantages and disadvantages of all the alternatives. They should be prepared to look at non-traditional funding solutions and to compromise. They should consider giving up some of their business in return for the cash they need to grow it if needs be – after all, the days of bank equity style lending have gone, and will not return for a good many years to come.

Robert: Is this a good time to make decisions? Paul: yes, if business owners have been deferring taking key decisions in the business, they should take them now. Growing their business will put it under more strain, decisions they have deferred could push the business to breaking point some time later on. They shouldn’t expect all their decisions to be a success, but at the same time shouldn’t allow fear of getting it ‘wrong’ to get in the way of making a decision now. It’s a case of feeling the fear but doing it anyway.

Robert: and how about competitors: Paul: it’s important to get the right balance between the short, medium and long term and daring to do something different from the competition, even if it costs them in the short term. Business owners should allow enough money within their cash flows to continually innovate and improve what they do and how you do it. Now is an ideal time for them to steal a march on their competitors, because for many of them, their sole focus will be on the short term, keeping their immediate costs down. While competitors sow the seeds of their ultimate downfall, business owners can sow their own seeds of long term success.

Robert: Isn’t it possible to over commit though? Paul: Yes business owners shouldn’t over commit the business in terms of overheads. Spend should be focused on things that drive your business forward – at the moment lenders and investors don’t want to see you spend their money on ‘luxuries’. And business owners shouldn’t be greedy – the needs of your business must come first, their wish list can come later on. In essence business owners should focus on net benefit rather than cost. They shouldn’t focus on the pure here and now cash cost of an item, but rather consider the net impact that spend will ultimately have on their business. Back in the 19th Century John Ruskin said ‘It’s unwise to pay too much, but it’s worse to pay too little. When you pay too much, you lose a little money — that is all. When you pay too little, you sometimes lose everything, because the thing you bought was incapable of doing the thing it was bought to do. The common law of business balance prohibits paying a little and getting a lot — it can’t be done. If you deal with the lowest bidder, it is well to add something for the risk you run, and if you do that you will have enough to pay for something better.’ It was true then, it remains true today, yet most of a small businesses competitors will ignore Ruskin’s words and simply go for the cheapest.

Robert: Have you got a final thought? Paul: Yes I have and it’s this..business owners should work closely with their external accountants, they should be an integral part of your decision making process, part of your inner circle management team. They will see things business owners would not otherwise and their business decisions will be more rounded. And if their external accountants are unwilling or unable to provide the support you need, then they should be replaced. Just because a business is growing doesn’t mean its engine will not come to a grinding halt if the business owner doesn’t make sure its oil, its cash, is well topped up. It’s hard work making sure a business has enough cash to finance its growth but it’s a challenge business owners must take on if they are to achieve that growth without risking all.

Robert: Paul, thanks for that, some useful advice for all of us. Paul: You’re welcome

Most owners of small limited company businesses are doing all they can to save money right now.  Many do so by taking the bulk of their drawings from their company by way of a dividend rather than remuneration through the paye system.  They do this because it saves national insurance, a large and growing number.  However, this is not without risk because unless they follow all the procedures for legally doing so (and most owners have no idea what the procedures are!), if the company later goes into liquidation or administration its insolvency practitioner will simply ask for the money back.  In broad terms, as  the dividend payments are made an overdrawn director’s loan account is created (an amount the business owner owes to the company).  However as the credit entry writing this off either is invalid, because the procedures to validate it have not been followed properly, or the entries have not been made (for example with late dividend payments), the debtor balance is repayable.  And there is no margin for error, mistake or omission in the procedures – you either get them right or not.

Let’s go back to a few basic principles arising from the statute and case law on this subject:

1. The law requires that all administrators and liquidators investigate companies over which they are appointed.  One of the purposes of that investigation is to ascertain whether monies could be recovered for the benefit of creditors.  The insolvency practitioners’ prime duties are owed to the creditors, not to you the director/shareholder of the company.  One source of potential recovery of assets is from you, if you have taken illegal dividends.
2. Dividends can only be paid out of distributable profits.  In broad terms this is the balance shown on the company’s balance sheet for its ‘profit and loss account’ – the total profits (less losses) you have made over time but not paid out.  If the company does not have a positive profit and loss balance, then you cannot legally pay yourself a dividend.  If you do so, the liquidator or administrator will ask you for the money back because all you have done is create an overdrawn director’s loan account.
3. Assuming your company has ‘distributable profits’, you still have to go through several legal hoops, and at the appropriate time, to be able to safely draw dividends from them.  You cannot go through these hoops later on, after the company has gone into insolvency as one accountant recently tried on a case I am dealing with – again you will be asked for the money back.  Insolvency practitioners see many cases where the paperwork doesn’t exist because the paperwork has been left for the accountant to sort out when he prepares the annual accounts.  Often the company goes into liquidation before the paperwork is prepared.
4. Accounts have to be drawn up on a proper basis proving that the company has sufficient distributable profits to pay the dividends – these can either be the previous year’s filed accounts or more recent management accounts but either way, they have to be drawn up using proper accounting principles – a ‘back of a fag packet’ exercise will simply not do.
5. Having demonstrated the company has sufficient distributable reserves to pay the dividends, you then have to hold a meeting of the members authorising its declaration and payment.  This meeting has to be properly recorded, even if you are the sole shareholder!  If it is not properly recorded, any dividends you have taken will be illegal and repayable.
6. Those minutes have to show that you have properly considered the effect of the dividend on the future viability of the company.  If the dividend leaves the company in a weakened financial position, prone to collapse, it can be upset by the insolvency practitioner: you could see yourself sued for misfeasance (thecourts have held that the taking of excessive dividends gives rise to an action for misfeasance) and you could also be banned as a director.  This is because the reasonableness of your actions will be assessed by both the insolvency practitioner and BERR, and if you have not done as the man on the Clapham omnibus would have done under the circumstances, if your actions have exposed the company’s creditors, you will be held accountable.

In conclusion, there are real drawbacks to taking dividends from a weakened company.  Most small business owners simply go into these things blind, thinking that they can what monies they like from their company how and when they want and somehow backfill later, deferring the paperwork to their accountant.  To do so is very risky indeed.  To reduce the risks of personal attack from an insolvency practitioner or the Revenue, all the right procedures have to be gone through at the right time, and that costs money, eliminating some of the savings made.   On a practical level an insolvency practitioner will not query your reasonable remuneration passing through the paye system but he will look to you to repay even small amounts of dividends paid illegally.  And he will always report illegal dividends to the DTI, who could ban you from being a director.  And he could sue you for misfeasance.  But it’s even worse than that!  HM Revenue & Customs could also ask you to personally pay the tax on the money you have taken from the company – they can treat the money paid to you as net remuneration and gross it up.

If you go to an accountant on the basis of expense in an attempt to save money, and as a consequence you do not work closely with him/her and fail to do all the right things at the right time to record and justify any dividends you take, you are risking yourself unnecessarily.  It’s far better for you to merely pass your drawings through the paye system and pay over the tax.  This is yet another instance where scrimping on professional support or picking the wrong accountant can cost you very dear indeed.

Paul Brindley

Midland Business Recovery