The results of a recent WHK small and medium sized business survey highlighted the continued difficulty for small & medium businesses (SMEs) have in Australia  accessing affordable finance.

On top of this, the ATO has announced a new, tougher, approach to their debt recovery, and proposed changes to the penalties business directors can face.

Sam Morris (Principal, Tax Consulting) and William Kyriakou (Manager, Business Advisory) discuss some of the implications these developments have for business and explore some practical solutions.

Sam Morris (SM): William, the recent SME Pulse Survey indicates that many businesses across Australia are finding it difficult to source and secure affordable finance to fund their businesses. What are your thoughts?

William Kyriakou (WK): We often observe mixed results with our clients and their business associates when it comes to lending.

One common theme we see is that businesses that can display  a record of controlled debt and strong financial management and controls, will often find credit far easier to access.

In contrast, those businesses that have had a need to increase borrowings or refinance their arrangements, but who haven't spent the time presenting their financial record in the strongest manner, or do have financials that show weak financial management and control, often have to jump through many more hoops with the banks to secure funding.

Even then, the funding might not be ideal; they may find their personal assets are needed as security and therefore exposed to greater risk, or their interest rate is higher than the norm.

SM: In these situations, what are some of the traps that businesses can find themselves in?

WK: As we all know, cash flow is the lifeblood of a business. Consequently, when a business cannot access the finance that it needs when it needs it, the owners or directors sometimes resort to more desperate measures. These can include dragging out their creditor payments, not paying their BAS obligations on time (such as GST and PAYG withholding tax) and not paying their super obligations each quarter. Whilst these may give temporary relief from a business's funding problems, it is only a short term measure and cannot be relied upon to keep getting them out of trouble. How long until the creditors do not want to deal with them any more? How long until the ATO takes action against them?

SM: So these are some of the common traps that people find themselves in, but what are the signs and indicators that they are on that path and what are some of the basic things that businesses can do to strengthen their financial management and control?

WK: In my experience you need to go back to basics. When the global economy was experiencing the good times, many businesses relaxed their control of the basic things.  The reasoning which allowed this to creep in was confidence that their debtors would eventually pay, the ATO appeared liberal in entering into payment arrangements if needed, revenues were arguably stronger than ever, and there was a perceived ability for owners to draw from the business to fund their lifestyle; all seemingly with no ill effect.  All those weaknesses that were hidden during the boom were exposed when the GFC hit and cash dried up.

SM: What are some of the basic things you refer to?

WK: With respect to debtors: close monitoring of debtor levels and debtor days, and having a reliable and documented debt recovery procedure (including trained up personnel). Furthermore, it is important to be informed of the benchmark trade terms for your industry, to build those into your contracts, and also hold your customers to it.  Finally, wherever possible, try not to be dependant on a small number of clients/customers driving most of your revenue.

With respect to inventory: have a good inventory ordering system that can also monitor stock levels, and ensure you properly delegate responsibility for ordering and maintaining inventory.

With respect to creditors: try to negotiate favorable terms with all new creditors (don't just automatically accept their standard terms), and if it is appropriate to do so, seek to review or extend credit terms with existing suppliers on an annual basis.  Furthermore, relying on one supplier to obtain a supply that is ‘key' to your business is a major risk; have a back up plan.

With respect to financial monitoring and management: ensure you maintain up to date reconciled financial records (and report to management at least on a monthly basis).  Have end of year financial statements prepared straight away (in case a banker or potential investor wants to see them).  Ensure both cash flow and profit and loss forecasts are prepared and reviewed regularly (monthly) to track performance against it; forecasts are especially important to highlight any future cash shortfalls so that you can begin to plan now, not when the funding is needed. Ensure a capital expenditure plan is in place, and ensure that the expenditure is actually needed (to increase capacity, extend geographical presence, etc) and that there is a business case for it. Finally, have debt, retirement and dividend/distribution plans, and link these in to the cash flow forecasts to ensure there are no unexpected shortfalls.

WK: Now Sam, I mentioned earlier that businesses sometimes fall into the trap of using the ATO or their employees' superannuation fund as their banker when things are tight. Asa  Tax professional, what are your thought's on the ATO's much firmer approach to debt?

SM: As far as the ATO are concerned, the GFC is over and they are taking a much firmer approach to debt recovery. We are no longer seeing interest-free payment arrangements, the length of term with which to pay has been greatly reduced and defaulting arrangements are dealt with quickly and consistently; often going straight to legal stage rather than a revised arrangement. This is a surprise for taxpayers who have relied on leniency in the past.

WK: What about the proposed changes to the Director's Penalty regime?

SM: New legislation was presented to the House of Representatives on 13 October 2011.  Although this has been postponed for further consultation until the New Year, this is intended to extend the director penalty regime making directors liable for unpaid superannuation guarantee amounts and enabling the Commissioner to recover unpaid and unreported PAYG withholding and super guarantee 3 months after the due date and without issuing a Director Penalty Notice. The proposals even extend to the ATO recovering funds directly from a bank or creditor of the taxpayer.

The proposed legislation can also disallow a Director offsetting personal PAYG in their own tax return if there are unpaid amounts for employees plus they can be liable for a new Non-Compliance Tax.

WK: Do you thin the ATO will introduce any transitional provisions?

SM: In its current form the legislation does not contemplate transitional provisions. This means that if businesses are behind on their withholding and super guarantee payments they should seek advice and get their affairs in order as soon as possible. It is likely that we could see a number of taxpayers affected by this legislation before the end of this current financial year if Royal Assent is received in early 2012. Importantly the way the rules are proposed to work, action will only be taken once Royal Assent is received but is likely to apply to unpaid amounts in the months leading up to that date.