Archives for September 2014

Forecasting tools for every SME business toolbox

Most Small and Medium Enterprises (SME) have an accounting software package, engage a book-keeper to balance the books, have an accountant prepare year-end financials and tax returns, and will retain boxes full of source documents for as long as they are required to do so1.  Often the compliance burden is seen as exactly that, a burden that while relevant to understanding their position, performance and how much tax they need to pay, is not terribly helpful as a management tool to manage and drive their business forward.  But this need not be the case.

There are a lot of things that differentiate a poor business from a good one.  From a financial perspective, those businesses that closely monitor and respond to changes in their position, performance and liquidity (cash resources), are likely to run operationally better and be in a stronger position to develop and implement more effective growth strategies.

This blog explores at a handful of financial management tools that will help the typical SME business manage its day-to-day operations and help shape its strategy.

The three-way forecast

Most businesses will set an annual P&L budget built from a combination of previous years results, the owner’s growth aspirations, market demand and other economic factors, and sometimes with little or no science at all.  This is an important business discipline.

The process requires you to develop a series of assumptions to drive each individual line of forecast income and expenditure on a monthly basis.  Some assumptions are easier to formulate than others as they may be based on the fixed price nature of items of expenditure, while others will require more subjectivity and ultimately be a sensible estimate.  To formulate assumptions you need to look at:

  • your previous results – often this will be the best indication of what you have demonstrated you can deliver
  • the pricing and length of current contracts both with customers and suppliers
  • interest rate forecasts for variable debt
  • annual rental increases stipulated in your lease
  • economic factors including your industry’s growth
  • your current sales pipeline can help some businesses more accurately forecast – particularly in the earlier months
  • if you are a services business consider your capacity to deliver – make sure you have enough people with the right amount of time available to meet your budget
  • if you are a retailer, wholesaler or manufacturer consider your available inventory levels and pricing
  • think about your phasing of income and expenditure over the year and the seasonality relevant to your business

Once you have formulated your P&L budget you have a realistic base case operating scenario for the business to work toward achieving.  Now it is time for the prudent to think about the things that if they were to occur would have the most material impact (positively or negatively) on your business’ ability to deliver its forecast.  This is known as undertaking a sensitivity analysis to your forecast P&L so you can try to avoid negative scenarios and work towards achieving the positive outcomes..

It is once management have a forecast to work towards that for many SMEs the planning stops.  This is an unfortunate trap that far too many businesses get caught in and it is not until the profits are delivered at expectations but the business has run out of cash, that management realise they may have a problem on their hands.  Remember that an insolvent business is one that cannot afford to pay its debts as and when they fall due not necessarily an unprofitable business – although related, distinctively different and important to understand.  This is why you need to take your P&L forecast and ensure it interacts with a forecast balance sheet and cash flow statement.

Getting a P&L, a balance sheet and a cash flow forecast to talk to each other and reconcile can be tricky, but essentially you need to:

  • take your opening balance sheet position from your prior years financial results and your newly developed P&L forecast
  • from the P&L forecast develop timing assumptions for the payment of creditors, receipts from debtors and the take-up of inventory.  Often debtor days, creditor days and inventory days sourced from previous results can be helpful in determining realistic payment cycles.  You will also need to unwind the opening balances on your balance sheet (ie. you need to pay creditors from the prior period in the current period).  These assumptions are important and will have a large impact on your cash position
  • link non-cash items of expenditure to the relevant asset on the balance sheet (ie. depreciation and amortisation).  This wont impact your cash position
  • consider the amortisation of any loans required over the period (this will reduce the loan and reduce cash)
  • consider items of capital expenditure not considered in the P&L and the cash outlays required

You now have a P&L forecast, a balance sheet forecast and a cash flow forecast.  The cash balance in the balance sheet should reconcile to the cash flow forecast and the net profit on the P&L should reconcile to the increase in equity in the balance sheet.

Now it is important to keep yourself accountable.  Prepare a set of management accounts every month and compare your actual results to your forecast results.  Use this to identify and respond to trends.  If you find that you are falling well short of your forecast, you can always re-forecast.  The more accurate the forecast you are working to, the more control of your financial position you will have.

The short term cash flow

The short term cash flow is a tool to help manage the intra-month cash position of the business.  It will be much more relevant for cash and working capital intensive businesses than others, but every business can benefit from a more detailed understanding of their short term cash position.  Short term cash flow forecasts are often stand alone tools (without the need to link them to P&L’s and balance sheets) that involve more precise assumptions over a 13 week period.  You are always going to have more certainty over your debtor collections next month than you will over your collections in 12 months time.  Depending on the business, the short term cash flow will forecast the receipts and payments on either a weekly or daily basis (use your judgement).  The tool should be used by management to identify and remedy any intra-month liquidity constraints identified by the forecast.  Unlike longer term forecasts that will often be set in place for the year, the short term cash flow needs to be a dynamic tool that should be updated either daily or weekly to track the forecast cash position in as close to real time as possible.

The return on investment consideration

Entrepreneurial small business owners often have the ability to identify an income producing asset and quickly attribute a value to purchase the asset and start driving growth.  This is great when the income associated with the acquisition, when adjusted for the time value of money, exceeds the expenditure following as short as possible “pay-back” period but can be troublesome if things don’t work out exactly how they thought.  An SME owner should consider the following before committing to outlaying new capital on an income-producing asset:

  • What are the cash flows (not profits) that the asset is forecast to generate once operational?
  • What are the sensitivities to those cash flows?
  • What are all the costs associated with the acquisition (consider professional fees, assessments, commissioning, decommissioning, training etc)?
  • What is the rate of return required (a ten year government bond returns 3.45%2 relatively risk free) or if debt funded the cost of funding?
  • What is the pay-back period for the asset – how long will it take to pay back the outlay before surplus cash flows are produced?
  • How do the sensitivities impact the length of the pay-back period?



As a chartered accountant and business advisor for over ten years, I have advised a number of distressed businesses on implementing turn-around strategies.  A common theme with all clients of that nature is poor viability around their forecast position (or no forecasting at all).  A small investment in developing and entrenching these tools within your business can accelerate your businesses growth.  At Prosperity Advisers, we can work with you to develop a three-way forecast, implement a short term cash flow forecast and consider your return on proposed investments.  Call us for an obligation free discussion.



  1. Seven years for a company per the Corporations Act 2001 and generally five years for small business taxpayers per the Income Tax Assessment Act 1936.
  2. As at 8 September 2014



Government freezes super guarantee

The government has announced that it will freeze the superannuation guarantee at 9.5% until 2021.  Under previous plans, the super contributions paid by employers had been set to increase in 0.5% increments from the current rate of 9.5% until they reached 12% in 2019/2020. It will now be 2025 by the time the guarantee reaches 12%. The rationale behind the freeze on super is that it will ease pressure on the federal budget, due to the significant tax concessions associated with superannuation contributions.

There have been many claims by superannuation industry representatives about how this will impact the size of future superannuation accounts. While these figures can only amount to speculation because nobody can accurately predict wages, fund growth rates and the future taxation of superannuation, it is certain that these changes will result in smaller superannuation accounts. It is also likely that the freeze will disproportionately affect younger Australians, women, low-income earners and part time/casual employees.

There are, however, some strategies that may be useful to individuals seeking to counterbalance the impact of the freeze:

  • Salary sacrificing into your super is a great way to offset the impact of the superannuation guarantee freeze. The money that you salary sacrifice into super, known as concessional contributions, will be taxed at 15%, which for most people is significantly lower than their marginal tax rate. Therefore, salary sacrificing is a particularly effective tax strategy for high-income earners. Concessional contributions are capped at $30 000 per year for most people and $35 000 per year for over 50s. For low-income earners, the government co-contribution is a great way to boost super balances. If you earn under $34 448, the government will contribute 50c for every $1 you put into your super account from your after-tax income (up to a total co-contribution amount of $500). If you earn anywhere up to $49 448, you may also be eligible for reduced co-contribution payments.
  • If you are a low-income earner or are taking a break from work, it may be worth investigating the possibility of your partner making super contributions on your behalf. If you earn less than $13 800, then your partner will be eligible for a low-income spouse tax offset with a maximum value of $540.
  • It may also be beneficial to re-examine your superannuation investment strategy, considering the returns and risks involved with different investment options. Your investment strategy choices should be informed by your age, retirement goals and level of comfort with risk.

Regardless of whether or not the super guarantee freeze has affected your superannuation plans, now is a good time to start putting some serious thought into your superannuation, and the retirement that you want.

Transferring a business property into your SMSF

Under a limited set of circumstances, it is possible for SMSF members to make non-cash contributions, also known as in-specie contributions, to their funds.  One way in which this can be done involves the transfer of a ‘business real property’ to an SMSF.

Using a combination of the non-concessional contributions cap and the CGT retirement exemption, it can be possible for business owners to transfer their commercial property into their SMSF with a number of tax advantages.

Property requirements

For a property to be considered a ‘business real property’ it must be used wholly and exclusively for business purposes. In order to be transferred into the SMSF, it must be unencumbered, meaning that it cannot have any outstanding debts or loans associated with it. If you are interested in transferring a ‘business real property’ with outstanding debt, you may be able to do so provided that you settle the debt before you transfer the property. The commercial property may be a shop, industrial space or a farm, and there are some slight exemptions to the exclusive business use specification for farms.

Transferring the property

The property must first be valued by an independent and appropriately qualified party. The transfer of the property must be recorded at market value and will also trigger a CGT event. If your SMSF has enough liquid capital to purchase the property outright, then this is allowable.  However, as many SMSFs do not have sufficient capital to do this, it may be possible for you to use your non-concessional contributions cap to cover the outstanding balance. For example, if your property is valued at $500 000, and your SMSF has $300 000 cash, you may be able to transfer the property, and count the remaining $200 000 as part of your non-concessional contributions cap. It is also possible for your SMSF to use an LRBA to borrow money to acquire the property. However, this has complex compliance requirements, and it is advisable to seek legal advice if you wish to pursue this course of action.

Using the CGT retirement concession

The CGT retirement concession allows business owners exemption from CGT on business assets up to the value of $500 000 over a lifetime.  If you are over 55, there are no associated conditions, however, if you are under 55 then you must place the money into a superannuation fund to receive the exemption.  This means that if you are under 55 and wishing to transfer a ‘business real property’ into your SMSF, you can potentially do so without incurring any CGT liability (up to the value of $500 000).

Getting the finance you need to ensure business success

Business lending is shrinking as banks continue to favour home loans over business loans in their short-term approach to capital use and returns. It is stifling the economy and it is a major frustration for businesses that are seeking capital to fund their growth. In their recent submission to David Murray’s financial system enquiry, Industry Super Australia confirmed that the amount of commercial lending for every dollar of residential property lending has plunged from $3.84 to $1.62 over the past 25 years. The land of opportunity has become the land of property.

How do borrowers navigate these changes? Communication between borrowers and lenders is the key to a successful banking relationship. Bankers do not like surprises. As a borrower, be proactive and provide financial information that is both timely and accurate. Prepare and deliver on financial forecasts and projected financial covenant ratios. These add to a borrower’s credibility and offer opportunities to negotiate during the loan renewal process. Additionally, business owners should stay focused on their core business and have a solid business plan with contingencies in place.

So businesses who are seeking funding need to carefully consider the way they frame their finance proposal to their banker, positioning it in the best possible light. A professional, well-thought out application with strong supporting documentation is critical. Understanding what banks are looking for will help you get it right first time and improve your chances of success.

Banks typically look for three major elements when they assess your business’ credit risk. These are commonly known as ‘The three Cs’.

The first critically is ‘character’.

Bankers will assess your character by reviewing a range of documents that provide information about your history, track record and experience in business. They are seeking to understand your commitment to a relationship with the bank. Considerations include:

  • Have you been able to meet your forecasts?
  • What is your repayment history like?
  • Do you do what you say you will do?

The bank will also want to see that you have plenty of ‘skin in the game’. Are you contributing enough to your own cash or equity to the purchase or new project?

The second thing a banker will look for is ‘collateral’.

Here the bank ‘credit department’ reigns supreme. They will be seeking all the first mortgage “bricks and mortar” security they can get their hands on supported by a mortgage over your equipment, other assets of the business and personal guarantees from directors. Think twice about pledging all of your assets if you can avoid it as it limits your borrowing options in the future.

Thirdly, a banker wants to look at your ‘capacity’.

They need to know that your earnings are sufficient to pay the loan back without creating distress. When you apply for the loan, you will be asked to outline all of your income, and provide comprehensive financial data on the business. These will include cash flow and profit and loss forecasts and a robust business plan.

Once you have satisfied the ‘three Cs’ there remains much devil in the detail. Your ranking in this area will determine how much negotiation leverage you have around some very important final points namely:

Covenants – These are the ratios and conditions that the bank will monitor to ensure satisfactory performance of your loan. They may include the ageing of your debtor’s maximum, stock levels and interest cover (the number of times your net profit exceeds your interest bill). Breaking these covenants give the bank the power to charge penalty interest rates and even call in your loan. So it is sensible to ensure they are achievable. While it is important to monitor them once in place, practically they are usually regarded as a guideline by the bank and a lever to deal with relationships that have deteriorated beyond repair.

Security – We live in difficult and uncertain financial times. While it is necessary to ensure the bank has ‘sufficient’ security, do not be overly generous. Look to exclude the home and personal assets where possible. Maintaining separate banking relationships for business and personal loans can give you options and keep each bank on their toes.

Repayment terms – Interest only terms take the cash flow pressure off your business by excluding the additional burden of the extra loan portion payment particularly in the early period of the loan. Banks however are keen to see a start to the repayment of their loan and are reluctant to extend interest only beyond two to three years.

Even if you satisfy the three ‘Cs’ and all other lending criteria you may experience variations between banks so it’s important to get some advice. Some banks have particular industry focuses (and usually specialised products to match) and others will seek to reduce their exposure to a type of business purely because the bank has a high total exposure to that area they are seeking to reduce on a pure risk balance basis.

In a challenging borrowing environment a thorough understanding of how banks assess your position; a well thought out finance proposal; and careful consideration of the terms will give you the best chance to obtain the finance you need to ensure business success.